Is a Recession Coming?

In December 2007, Larry Kudlow, then a talking head for the business network CNBC, proclaimed, “There’s no recession coming. It’s not going to happen.” That same month, the economy plunged into the worst economic downturn since the Great Depression.

This week, Larry Kudlow, now the director of the National Economic Council, stood on the White House lawn and struck a familiar note: “I’m reading some of the weirdest stuff [about] how a recession is right around the corner. Nonsense,” he said. “Recession is so far in the distance, I can’t see it.”

Perhaps, as morning follows the rooster’s crow, an imminent recession looms behind Kudlow’s latest optimistic squawk. The outcome certainly seems possible if you’ve recently been torturing yourself by following the stock market. After the Dow Jones Industrial Average sank 550 points on Tuesday, the past few weeks qualify as no mere correction, but as one of the worst stock meltdowns of the past few decades. Some analysts say it could get worse.

Read: How the Great Recession hurt Americans’ health

Cascading stock prices might seem like a random crisis if you’ve been paying attention to the overall economy, which is booming. At 3.7 percent, the official unemployment rate is the lowest of this century. Job satisfaction is at its highest level in more than a decade. Small-business and consumer confidence hit record highs this year.

Observing the gap between Wall Street jitters and Main Street optimism, some are inclined to point out that “the stock market is not the economy.” But you should resist that temptation. The stock market is not the entire economy. (Neither is wage growth or health-care spending.) Rather, the stock market is a part of the economy that reflects both the value of capital investment in public companies and a prediction of their future earnings. As labor costs increase (good news for workers), and interest rates creep up (good news for traditional savings accounts), cost of business increases for many large companies, which can hurt their stock value.

For many years, corporate profits thrived as labor costs were low. Now corporate profits are at risk as labor costs are rising.

But this parallelism isn’t very satisfying for investors and businesspeople who want to know what happens next. Could a downturn on Wall Street trigger a decline in business investment that could ripple throughout the economy? Or, to cut straight to the point, is there gonna be a recession, or not?

Read: The U.S. isn’t prepared for the next recession.

One way to predict the likelihood of a recession today is to look back at the past few downturns and evaluate whether the U.S. economy is in danger of repeating history.

Let’s start with the 1970s, when a series of oil crises contributed to a rare period of stagflation. (The portmanteau signifies a combination of stagnant growth and high inflation.) Today, conversely, oil prices are low, which helps consumers and businesses feel richer while hurting the energy industry. Despite the fact that the U.S. is now the world’s leading oil producer, America is predominantly a consumer-and-services economy, not an oil-and-exports economy. Even a long-term decline in oil prices is, therefore, unlikely to cause a serious downturn.

The recession of the early 1980s was a byproduct of the Federal Reserve’s decision to jack up interest rates to cool off rampant inflation—somewhat like a fire department flooding a house to save it from a fire. But today’s economy is neither burning nor flooding. Although the Fed is again raising rates—and there is a robust debate among monetary-policy analysts over whether, and how fast, it should do so—the baseline couldn’t be more different. Inflation is low, and—relatively speaking—so are rates.

The next two recessions, in the early 1990s and early 2000s, were more complex in origin. The 1987 stock-market crash—in which the Dow lost more than a fifth of its value in a matter of days—coincided with the collapse of the savings-and-loan industry in the late 1980s. Because the government bailout of the S&L banks contributed to fears of rising federal deficits, the Fed quickly raised interest rates. Adding to the economy’s woes, the Iraqi invasion of Kuwait in 1990 caused oil prices to double in five months. Consumer confidence tanked, taking economic growth down with it. The 2001 recession probably had little to do with the 9/11 terrorist attacks or the bursting of the dot-com bubble. A 2003 analysis of the downturn by the Federal Reserve Bank of St. Louis listed several variables, including a sudden decline in exports and a sharp drop in business investment in the first half of 2001.

Read: The Great Recession is still with us.

How many of these factors trouble today’s economy? There is no national mortgage-lending scandal, no bailout for banks, no sudden increases in interest rates, and no spike in oil prices caused by a war in the Middle East. There is, however, the issue of exports. President Donald Trump’s trade standoffs have hurt soy farmers and other companies that do business with China. The International Monetary Fund has predicted that Trump’s policies have already reduced global trade by several hundred billion dollars, and four in five economists say that White House trade policy will reduce U.S. growth. For the past 100 years, the U.S. economy has been big and resilient enough to shake off problems in other countries. But a downturn in China—caused by high debt and accelerated by Trump’s trade war—could be the cold that gets the world economy sick.

Finally, there’s the Great Recession, which—to simplify wildly—spun out of housing debt. Although practically nobody expects the world to face anything remotely similar to the international economic apocalypse of 2008, it is concerning that sales of new single-family homes fell 22 percent in September from their 2017 peak, and that residential investment has been a drag on GDP growth all year. Also of concern is that even as stocks and profits have soared, companies have gobbled up debt at low interest rates, which could become a serious burden if rates rise too quickly. Corporate debt has tripled in the past eight years to match its historic highs, according to Ruchir Sharma, the chief global strategist at Morgan Stanley Investment Management.

To understand whether this fateful combination— high debt plus a cooling housing sector—could produce a sequel to the Great Recession, I reached out to Bill McBride, a famously prescient economic analyst and the author of the Calculated Risk blog. “I do not see any signs of a recession in the next six months,” McBride said. “I think the economy is pretty solid. Recently new home sales have slowed due to several headwinds, mostly higher mortgage rates and the new tax policy.” As the Millennial generation continues to pay down student debt and move into its peak-earning years, he predicted “further increases in new-home sales and single-family starts over the next couple of years.” His verdict: a slowdown, perhaps; but not a downturn.

If you’re going to worry, you should worry about three things: exports, China, and maybe the looming shadow of corporate debt. But nothing in the economy seems to predict an imminent recession.

Or at least that was my conclusion before Bill McBride sent me a follow-up email.

“Just saw Larry Kudlow’s remarks. Maybe I’m wrong!”