U.S. recession risks have been a headline over the last few weeks as the markets sold off.
“Goldman Sachs and Moody’s Analytics in recent days joined forecasters raising alarm about the increased likelihood of an economic downturn. The warnings coincided with a market plunge touched off by U.S. tariffs against Canada, Mexico, and China, some of which were delayed. Retaliatory tariffs issued by China on Monday deepened a trade war between the world’s two largest economies.” – ABC News
That concern is interesting as there was no such concern in January.
“As of January, the risk of a U.S. recession was considered small. A low unemployment rate and rising wages meant consumers were continuing to spend, inflation was drifting down towards the Federal Reserve’s 2% target, and the U.S. central bank had cut interest rates by a full percentage point since September. Fed officials considered it a stable foundation for continued growth, and many economists thought the central bank had nailed a “soft landing” from the high inflation of 2021 and 2022.” – Reuters.
Over the last couple of weeks, the market sell-off eclipsed 10% on an intraday basis, sending investor sentiment plummeting to levels usually seen during more significant declines and previous bear markets. While the markets have had a phenomenal run over the past two years, investors seemed to have forgotten that markets tend to correct now and then.
The one thing you can always count on during a sell-off is the media trying to formulate a headline to rationalize investor actions. During this particular decline, it was the return of a U.S. recession.
Of course, it is wise to remember that in 2022, we had the most anticipated recession ever, which failed to occur and preceded one of the strongest bull markets in recent history.
The problem with predicting recessions is that economists always work off of lagging economic data. Such is particularly the case with GDP, which is revised three times following the end of the quarter, 12 months, and 3 years later. Historically, given that lag, the timing of U.S. recessions can be off by 9 to 12 months before they are recognized by the National Bureau of Economic Research (NBER).
The chart below shows the lag between the onset and recognition of previous U.S. recessions.
The following table better shows the lag between the start and recognition of previous U.S. recessions. I have also noted the impact on financial markets as investors reprice earnings growth for a reversal in economic growth rates.
Investors must decide whether the current correction is “just a correction” or whether the risk of a U.S. recession is increasing.
Recession Indicators
Currently, few indicators suggest a U.S. recession is on the horizon. The Economic Composite Index (a comprehensive measure of economic activity comprised of more than 100 data points) is in expansionary territory. The EOCI index confirms the improvement in the 6-month rate of change in the Leading Economic Index (LEI), one of the best recession indicators, and current levels of economic growth. While economic growth will undoubtedly slow as all of the excess governmental spending under the previous Administration reverses, there is currently no recession warning in the data. That does not mean that such can not change in the future. However, for now, the risk of recession is extremely low.
Adding to that analysis, the economically weighted ISM composite index is also in expansionary territory, suggesting no current risk of recession. This composite index (80% service / 20% manufacturing) is why we wrote there was no recession risk in 2023 or 2024 despite inverted yield curves.
Lastly, Government spending remains robust, fueling economic growth. While the current Administration is looking to cut spending and reduce the deficit, which would weaken economic growth rates, it is making very little headway.
As shown, Federal spending has returned to the post-financial crisis exponential growth trend as the Government continues to use “Continuing Resolutions” to fund the Government. These resolutions, like the one just passed last week, automatically increase government spending by 8% annually. In other words, spending doubles every nine years, so debt levels continue to increase. However, that spending increase feeds into economic growth rates.
However, while there is minimal risk of recession currently, economic growth will slow in the coming quarters, impacting earnings growth expectations.
Economic Growth Is Slowing (And So Will Earnings)
Yes, as we have discussed many times, there are reasons to expect the economy to continue to slow down. However, a slower growth environment is far different from a recession.
Does that mean we can not have a recession? No. I am only suggesting that the current weight of evidence suggests slower growth, not negative growth.
With that said, there are certainly implications for slower economic growth, primarily the change to the main driver of financial markets: earnings. As discussed in “Estimates Have Gone Parabolic,” Wall Street analysts are optimistic about continued double-digit earnings growth into 2026.
“The current estimates are well above long-term trends, suggesting earnings will be closer to $220/share than $285.”
“Again, this is because earnings are a function of economic activity. Therefore, for earnings to match current estimates, expectations for economic growth must improve sharply. However, such seems unlikely given the impact of tariffs and reductions in government spending and employment. Therefore, it is far more likely that we will eventually see a sharp decrease in forward estimates.”
Therefore, given that earnings come from economic activity, slower economic growth will eventually impact earnings expectations. To better understand this concept, we can look at the correlation between annual changes in earnings growth and inflation-adjusted GDP. There are periods when earnings deviate from underlying economic activity.
However, those periods are due to pre- or post-recession earnings fluctuations. Economic and earnings growth are very close to the long-term correlation, but a slowdown will change that.
Given the high correlation between earnings and economic growth, it is essential to pay attention to that relationship. While it is possible for the markets to temporarily detach from underlying economic realities due to momentum and psychology, ultimately, the market can not outgrow the economy. This is why we pay close attention to the direction and trend of annual change in both markets and earnings estimates. Currently, forward earnings estimates are still expansionary and are not warning of an economic recession yet.
Conclusion: Staying Grounded Amid Market Volatility
While recession fears have resurfaced in the headlines following the recent market sell-off, the economic data does not yet support the narrative of an imminent downturn.
As I discussed in “The Risk Of Recession Is Not Zero,” there are things the government is currently engaged in that will impact economic growth. If those actions are combined with those of an already struggling consumer, the risk of recession will undoubtedly increase. However, as of today, the risk of recession is not 40% either. Could that change? Absolutely!
However, historically, recession calls tend to be premature, often relying on lagging indicators that only confirm economic contractions well after they have begun. Current indicators point to a slower economic expansion, not contraction. Although growth is slowing, a slower growth environment does not equate to a recession—a distinction investors must keep in mind.
The more significant concern for markets is the inevitable impact of slowing economic growth on corporate earnings expectations. With analysts projecting continued double-digit earnings growth into 2026, there is an apparent disconnect between these forecasts and the economic reality. History suggests that earnings will eventually revert to levels that align with economic activity, which could lead to further bouts of market volatility.
For investors, the key takeaway is to stay informed, focus on fundamentals, and avoid being swayed by short-term noise. While volatility and corrections are natural in market cycles, history shows that panic-driven decisions often lead to missed opportunities. As long as economic indicators remain expansionary, the risk of a recession remains low—though careful monitoring is warranted. Investors should continue to assess their portfolios, manage risk prudently, and position themselves for a gradual slowdown rather than an economic collapse.