Second, if we are gauging the next recession by the financial markets, then we should also be looking for indications of developing imbalances or shocks. Without those, the bear markets associated with recessions since World War II have been far less grizzly, yielding average losses of less than 30%.
So is there any kind of imbalance right now that could cause a grizzly bear market? There’s no way to know for sure, but if there were imbalances, they likely would be more noticeable by now. The excesses in the housing market in the 2000s were evident to many people, as were the high dot-com valuations before that. Less obvious, of course, was how large these bubbles had become and how painful and sudden their deflation would be.
This is not to say there aren’t areas of concern. Some might argue that equity valuations have become high enough to be called imbalanced, which could lead to a harsher recession.
The rising level of global debt, mainly corporate debt and sovereign debt in certain countries, also deserves scrutiny. The sovereign issue might be sustainable for the long term since most nations can control their currency supplies. In the corporate sector, however, debt-to-cash metrics indicate that U.S. companies are increasingly leveraged, which could mean trouble in a recession. Nevertheless, according to data from the Fed and the St. Louis Fed, new corporate debt issues declined in 2018, and the amounts of outstanding total debt securities are plateauing. That should ease some concern.
Also keep in mind that much of the debt in place today was issued at favorable (i.e., lower) interest rates, making the larger debt amounts easier to service.
Conclusion
The U.S. economy is in one of its most prolonged expansions in history. While people are anxious about the timing and gravity of the next swoon, there is good reason for optimism. Not all economic downturns are created equally. The economy operates in cycles. For every expansion period, there is a corresponding contraction. While current debt levels are certainly a cause for concern, there does not appear to be another major imbalance like the dot-com or housing bubbles on the horizon, and imbalances that have exacerbated previous recessions and fueled larger market losses are not readily apparent at this time.
To be clear, the inversion of the yield curve earlier this year rightly caused many to pause and reflect on the current and future state of the economy. It’s even possible that we may already be heading into a recession. The National Bureau of Economic Research frequently publishes data well after recessions have started or even at their conclusion. The 2001 recession ended in November of that year but was not declared to have occurred until November 26—when it was already over!
It must also be noted that a geopolitical shock or other outside force could change all the current conditions. These are simply impossible to predict.
Nevertheless, while caution is vital, there is reason to believe that the cliché “this time is different” might actually be appropriate. There will be another recession, but the next one may not be as long or as deep. That means it’s important to keep the traditional advice in mind: People should avoid market timing and keep a longer-term perspective.