US equity crash points to heightened risk of 2023 recession

Kieran Davies

Coolabah Capital

The stock market is signalling a heightened risk of a US recession in mid 2023 assuming no recovery in equity prices over the rest of this year. This is earlier than the signal from the more reliable yield curve, where economist estimates and market pricing of interest rates point to a heightened risk of recession in late 2023/early 2024 according to Coolabah's recession forecasting model. This suggests that while the Fed thinks a mild economic slowdown can contain inflation, financial markets are focused on the risk of a recession in the second half of next year to bring consumer prices under control.

The slope of the yield curve – combined with the Fed funds rate – continues to point to a low risk of recession in the US in the short term, although extended forecasts based on economist estimates and market pricing of interest rates currently point to a heightened risk of recession in late 2023/early 2024 based on our modelling.

The most widely-used, but less reliable, alternative to the yield curve as an indicator of the risk of recession is the stock market. The main problem with using equity prices is that they send more false signals of recession, as made clear by economist Paul Samuelson’s famous quote that, “the stock market has predicted nine out of the last five recessions”. 

The other issue is that stock prices provide only a short lead on the risk of recession, unlike the 12 month lead provided by the yield curve.

With these qualifications in mind, the chart below shows the risk of recession in the US in six months’ time based on a simple model of growth in US stock prices. 

Using monthly data, stock prices have fallen sharply and are now off ~19% from the end of last year. This suggests that the risk of recession in the US based on the signal from equity market is about 20% in six months’ time, which is similar to the signal provided on three previous occasions in recent years, one of which was near the 2020 recession.

However, on the assumption that there is no recovery in stock prices over the rest of this year, our model suggests that the risk of recession would rise to around 35% by the middle of 2023, which historically would be a strong recession signal from the stock market (the signal would naturally be stronger if equity prices continue to decline and fail to rebound later in the year).

Given that the forward estimates from our yield curve model pointed to a heightened risk of recession in late 2023/early 2024, the combined signal from the equities and bond markets suggests the risk of recession should be most apparent in the second half of 2023.

Although the Federal Reserve is forecasting that it will contain inflation by engineering a mild economic slowdown as the impact of pandemic-related disruptions on consumer prices fades, financial markets - including both bonds and equities - are signalling that the Federal Reserve may end up with a recession as it brings inflation under control. Coolabah has consistently warned investors about the risk of large equity and bond losses since the first half of 2021. You can read a summary of this research and our prior warnings here.

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Investments (Retail) Pty Limited (CCIR) (ACN 153 555 867) is an authorised representative (#000414337) of Coolabah Capital Institutional Investments Pty Ltd (CCII) (AFSL 482238). Both CCIR and CCII are wholly owned subsidiaries of Coolabah Capital Investments Pty Ltd. Equity Trustees Ltd (AFSL 240975) is the Responsible Entity for these funds. Equity Trustees Ltd is a subsidiary of EQT Holdings Limited (ACN 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...

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