Has a recession already been priced in?

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by KenBalbari

I don’t think so, no. I think many are still leaning to the soft landing scenario. Clearly there is no recession yet, but if there is going to be one, I think it will be mainly top down, starting with further declines in corporate profits, eventually leading to a weaker jobs market.

Bond markets recently though seem to be expecting the opposite. The declines in long term bond markets do not seem to be due to inflation expectations, market based measures there continue to be low. Instead, it seems to be real interest rates increasing. This seems to indicate bond markets are expecting an extended period of monetary tightness without this leading to any recession.

This leaves stocks looking a little overvalued though, relative to bonds, with S&P 500 earnings yield at 4.07% now vs. 10-year Treasuries at 4.78%. In a recession scenario, where earnings weaken further, this discrepancy gets greater, and you could see a flight out of stocks and into those bonds, which would look pretty attractive now in a low inflation recessionary scenario.

In a soft landing scenario though, those long bonds rates could remain fairly high, while inflation comes down enough that the Fed is able to normalize the yield curve by bringing short rates back down to the 4%-4.5% range sometime next year, without having caused any recession first. And stocks in this scenario could still be fairly attractive, as there certainly could earnings upside there.

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Finally, I guess you also have to consider the possibility of a significant resurgence in inflation. I don’t think this is that likely right now, but I don’t think it’s priced in either. And, that tends to be bad for both stock and bond markets.

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