This Recession-Forecasting Algorithm Hasn't Been Wrong in 65 Years -- and It Has an Ominous Message for Wall Street
News Summary
The U.S. stock market has experienced significant volatility since early 2025, including a "mini-crash" following President Trump's tariff policies and subsequent record highs after a temporary pause on tariffs. Moody's Analytics' new machine learning model projects a 48% probability of a U.S. recession within the next 12 months. Historically, any probability at or above 50% has been followed by a recession since 1960. While not at the 50% threshold, the article notes that figures well above 40% have consistently indicated an economic downturn. The model specifically identifies building permits, which have tapered to pandemic lows, as a critical predictor. The article highlights that the S&P 500's Shiller Price-to-Earnings (P/E) Ratio is near its second-priciest valuation in over 150 years, making the market vulnerable to a correction should a recession impact corporate earnings. However, a longer-term historical perspective suggests recessions are typically short-lived (averaging 10 months), while economic expansions are much longer (averaging five years). All 106 rolling 20-year periods for the S&P 500 since 1900 have produced positive annualized total returns, suggesting long-term investors should not panic over short-term downturns.
Background
In 2025, the U.S. stock market experienced significant volatility triggered by President Donald Trump's trade policies. Major indexes saw a "mini-crash" after tariff announcements, followed by a swift rebound to record highs when tariffs were paused. Currently, the S&P 500's Shiller P/E Ratio is approaching its second-priciest valuation in over 150 years. Meanwhile, economic recessions are a normal part of the economic cycle, historically proving short-lived compared to more extended periods of expansion.
In-Depth AI Insights
Given Moody's Analytics' ML model's near-flawless 65-year track record and its 48% recession probability, why isn't the market reacting more dramatically? - The market might be selectively interpreting the 48% probability as "close but not quite" the 50% threshold, allowing for a degree of optimism or denial. - President Trump's swift reversal on tariffs, moving from aggressive implementation to a 90-day pause, likely injected short-term bullish sentiment, overshadowing longer-term recessionary signals. - Investors, particularly with high valuations, might be more focused on immediate liquidity and corporate earnings data rather than a predictive algorithm, however historically accurate, possibly driven by FOMO (fear of missing out). Beyond building permits, do the Trump administration's trade policies and their geopolitical ramifications pose a greater underlying risk to the U.S. economic outlook? - Yes, while declining building permits signal internal economic weakness, the erratic and unpredictable nature of the Trump administration's "reciprocal tariffs" policy is a deeper, systemic risk. - Such policy uncertainty can defer corporate investment decisions, increase supply chain restructuring costs, and provoke retaliatory measures from trading partners, leading to long-term negative impacts on global trade and U.S. exports that transcend the volatility of a single economic indicator. - Trade policy instability can also exacerbate inflationary pressures or lead to job market volatility in specific sectors (e.g., manufacturing), eroding both consumer confidence and corporate profitability. How should long-term investors adjust their strategy to navigate both the warning from Moody's model and historical market resilience, especially considering elevated valuations? - Long-term investors should acknowledge that while short-term market corrections due to a recession are possible, historical data consistently show positive S&P 500 returns over 20-year rolling periods. - It's advisable to adopt a defensive posture, increasing exposure to sectors with stable cash flows, lower debt, and relatively inelastic demand during economic downturns (e.g., utilities, consumer staples). High-quality fixed-income assets could also be considered. - Utilize market pullbacks as buying opportunities for broad-based index funds, employing a dollar-cost averaging strategy to avoid panic selling quality assets during short-term volatility.