The probability of a recession is highly variable across different asset markets, according to JPMorgan. The Russell 2000 index indicates a 97% chance of an economic downturn, while 5-year Treasurys estimate it at 15%.
JPMorgan’s Chart of the Day reveals the inconsistency in recession odds when analyzing equity, credit, and commodity markets. The small-cap Russell 2000 index predicts a significant downturn with a 97% probability. This determination is based on a comparison of the current decline from peak to trough with previous recessions. In November 2021, the index experienced a 32% drop, close to the average 33% decline. The retrenchment of the Russell 2000 can be attributed to declining sentiment among retail investors who heavily engage in small-cap equities.
In contrast, the S&P 500 is indicating a more modest decline, suggesting a 41% probability of a recession. However, JPMorgan points out that the large-cap index faces a different set of risks. The note emphasizes that small-cap equities, given their higher cyclicality and sensitivity to interest rates, are more suitable for assessing cyclical risks. Thus, the current pricing of US small caps reflects significantly higher cyclical risk compared to large caps (S&P 500) and other asset classes.
Moving to other financial markets, 5-year US Treasury bonds exhibit a lower likelihood of a recession at 15%. In contrast, high-yield US debt shows a 19% probability, while investment-grade US debt indicates 29%. Additionally, base metals in the commodities market are pricing in an 85% probability of a recession.
These divergences reflect the overall uncertainty surrounding the direction of the US economy, with commentators presenting both soft-landing and recession scenarios. Investor Steve Eisman recently mentioned conflicting economic trends that have left Federal Reserve Chairman Jerome Powell perplexed, leading the central bank to maintain steady rates. Eisman suggested that Powell’s uncertainty about the various data points might be the reason for the pause in decision-making.
In conclusion, JPMorgan’s analysis highlights the disparity in recession probabilities across asset markets, emphasizing the significant risks associated with small-cap equities. The conflicting economic indicators continue to perplex experts and policymakers, making it challenging to determine the future trajectory of the US economy.
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