By: Isabel Wang, MarketWatch
With the U.S. stock market on track for its biggest annual decline in over a decade, fears that efforts by the Federal Reserve and other major central banks to bring down a surge in inflation will spark a major economic slowdown have moved front and center as the calendar flips to 2023.
Here are three recession scenarios for an economic slowdown and the potential market reaction:
A shallow and brief recession
Many analysts think the economy has enough inertia to grow slowly at least through the first half of 2023.
“To be sure a severe recession would be bearish for stocks yet given the resilience of the U.S. economy and the tight labor market, we are expecting a slowdown or shallow and brief recession,” said Nancy Tengler, CEO and chief investment officer of Laffer Tengler Investments. “That could allow stocks to rally in the second half of 2023 (after a volatile Q1) as they look around the recession corner.”
Tengler said that the current market consensus is too pessimistic because the consumer still has bandwidth and spending will hold up better than the naysayers predict in the tight labor market.
U.S. employers hired more workers than expected in November and raised wages, shrugging off most worries about a recession. The November jobs report showed the economy gained 263,000 jobs last month, topping Wall Street expectations, with the unemployment rate holding steady at 3.7%, remaining close to a half-century low.
However, job growth is expected to slow in 2023 as higher interest rates crimp investment and as more industries fully recover their prepandemic head count, but according to Julia Pollak, chief economist at ZipRecruiter, this kind of “substantial cooling” in labor market conditions will be far from recessionary.
The Congressional Budget Office’s estimate shows the number of employed Americans will rise from 158 million in 2022 to 174 million in 2052. Pollak said the economy should be “comfortable with even lower numbers of job gains in subsequent years.” Those projections imply net job gains of only 45,000 jobs a month on average over the next 30 years, absent an increase in U.S. population growth.
Mark Luschini, chief investment strategist at Janney Montgomery Scott, thinks the stock market is likely to bottom ahead of the actual beginning of the recession, with an anticipation of the “eventual recovery” on the other side of it.
“We expect stocks to struggle and continue to be under pressure over the coming months or a quarter or two, before ultimately establishing a more sustainable advance, perhaps in the second half of next year,” Luschini told MarketWatch via phone.
He attributed the economic resilience to the “healthy balance sheets” of individuals and households, which accumulated “abundance of savings” during the pandemic.
See: Did 2022 break Wall Street’s ‘fear gauge’? Why the VIX no longer reflects the sorry state of the stock market
A “swamp” recession
While a slew of forecasters think a recession in 2023 will be mild and brief, and will be followed by a strong economic recovery, one J.P. Morgan strategist said the economy would likely struggle to get out of it.
David Kelly, chief global strategist at J.P. Morgan Asset Management, argued that rather than falling off an “economic cliff,” such a recession would be more like sliding into an “economic swamp,” meaning it would be hard for the economy to bounce out of it.
The good news is that a prolonged period of economic swampiness should snuff out inflation and force the Federal Reserve to reverse a significant part of their 2022 monetary tightening, wrote Kelly in a November note.
“However, the flip side is that a mild recession would likely not create much additional pent-up demand and, assuming we see only a modest increase in unemployment, the employment and income boost from a falling unemployment rate would also be less than normal,” he said. “Perhaps most significantly, in contrast to each of the last four recessions, there is unlikely to be any significant fiscal stimulus to re-energize the economy.”
Wall Street analysts have warned stock-market investors that they should not expect any form of “Fed put” next year.
See: Is a 2023 stock-market rebound in store after 2022 selloff? What history says about back-to-back losing years.
No recession or a small technical recession
Economists at Goldman Sachs have doubled down on their call that the U.S. economy will probably achieve a soft landing, meaning the central bank could tame inflation without stunting economic growth. They also expect the economy to narrowly avoid a recession as inflation fades and unemployment nudges up slightly.
“Our economists say there’s a 35% probability that the U.S. tips into recession over the next year, an estimate that’s well below the median of 65% among forecasters in a Wall Street Journal survey,” said Goldman Sachs’ economists in their 2023 outlook. “The U.S. may avoid a downturn in part because data on economic activity is nowhere close to recessionary.”
After two consecutive quarters of negative gross domestic product (GDP) growth in early 2022, the U.S. economy expanded in the third quarter, growing at an annual 2.9% pace, government data shows.
Consecutive quarters of contracting GDP are often described as a “technical recession,” though the National Bureau of Economic Research, which serves as an arbiter of the business cycle, has a much broader definition of recession.
See: These five trading days accounted for nearly all of the S&P 500’s losses in 2022
U.S. stocks were on track Friday to finish the year not far from their 2022 lows in what’s set to be the worst year since 2008.
The S&P 500 SPX, -0.25% was down 19.2% year to date as of Thursday’s close, the second-to-last trading day of the year. Meanwhile, the Dow Jones Industrial Average DJIA, -0.22% dropped 8.6%, while the Nasdaq Composite COMP, -0.11% slumped 33% so far this year.