US May Be Nearing Recession
But the picture may be brightening in Europe and China.
Key takeaways
Recession risks are rising in the US despite real wage growth and a tight jobs market.
Globally, economic activity is picking up as China rebounds from COVID lockdowns and Europe enjoys a mild winter and lower energy costs.
Rising recessionary risks and the uncertain path of monetary policy raise the odds of continued ups and downs in the US stock market.
On the valuation front, fixed-income and non-US equities look relatively attractive.
Focus on diversification and disciplined investing strategies.
United States
The United States is in the late-cycle expansion phase with a rising likelihood of recession in 2023.
End-of-cycle dynamics include a tight labor market, declining profit margins, rising inventories, tightening credit conditions, contractionary monetary policy, and an inverted yield curve.
Constructively, real wage growth has improved as nominal wage growth remains high with inflation slowing. Positive real wage growth and a still-tight job market are supportive of the large consumer sector.
The pace of inflation has decelerated, helped by easing manufacturing supply-related pressures. However, tight labor markets have kept more persistent categories of inflation elevated, suggesting overall inflation may settle at levels higher than experienced in recent decades.
The Fed slowed its pace of rate hikes to 25 basis points in February and is likely to stop hiking rates during 2023. The central bank faces a difficult challenge in bringing core inflation back to near its target without prompting a significant downturn.
Global
The global business cycle backdrop is showing signs of desynchronization and early hopes for reacceleration, with activity ticking up in several large economies including Europe and China.
China's relaxation of significant COVID-19 restrictions has led to a quick rebound in services activity. Easing policy in several major sectors, including property, provides additional support of a cyclical uptick.
Europe's warmer-than-typical weather and lower energy prices have reduced recessionary risk and improved consumer and business sentiment.
Central banks in many economies are closer to the end of their hiking cycles than the beginning, although the lagged impact of monetary tightening may begin to weigh on activity later in 2023.
Asset allocation outlook
The US late-cycle phase and rising recessionary risks warrant smaller active allocation positions with a focus on diversified and disciplined investment strategies.
Slower liquidity growth, persistent inflation and recession risk, and greater monetary policy uncertainty raise the odds that market volatility will remain elevated.
Some of these challenging dynamics have been priced into markets in the form of more attractive valuations, particularly in fixed income and non-US equities.
The onset of recession typically implies a challenging time for riskier assets and outperformance of more-defensive categories. Still, recessions can also sow the seeds of greater investment opportunities once they are underway.
Business cycle framework
The business cycle, which is the pattern of cyclical fluctuations in an economy over a few years, can influence asset returns over an intermediate-term horizon. Cyclical allocation tilts are only one investment tool, and any adjustments should be considered within the context of long-term portfolio construction principles and strategic asset allocation positioning.
The diagram above is a hypothetical illustration of the business cycle, the pattern of cyclical fluctuations in an economy over a few years that can influence asset returns over an intermediate-term horizon. There is not always a chronological, linear progression among the phases of the business cycle, and there have been cycles when the economy has skipped a phase or retraced an earlier one. A growth recession is a significant decline in activity relative to a country's long-term economic potential. Source: Fidelity Investments (AART), as of 02/06/2023.