Is the U.S. Economy in a Recession?

On the back of small gains yesterday, stocks opened lower this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) down 0.2% and 0.1%, respectively, as of 10:05 a.m. EST.

The macro view
In an interview for Yahoo! Finance's Breakout, Rob Arnott, the CEO of Research Affiliates said:

If we wound up with a negative GDP [growth in the fourth quarter] with a surge in end-of-year dividends and bonus payouts that would have been made this quarter, what's this quarter going to look like? I'm concerned. I think we're definitely in a slowdown relative to last year, which was anemic enough, and quite possible already in recession. If that's the case, the market is shrugging off recession, fiscal cliff, debt ceiling, and Europe -- well, that's a lot to shrug off.

Is the U.S. economy in recession? I think it's unlikely. The following graph shows a monthly series of the probability of recession, as derived by a model based on four variables: nonfarm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales. The vertical bars of grey shading represent actual recessions.

Note that the most recent probability estimate for November, 0.22%, is much lower than the indicator has been at the start of any recession since 1967, with the possible exception of the Nov. 1973 to March 1975 recession (the indicator was at just 0.32% in Oct. 1973).

Furthermore, last quarter's GDP growth was barely negative at -0.1% -- and this was the first estimate, which is often subject to considerable volatility once the revisions come in. While it's not impossible, I don't think we are in a recession. Nevertheless, I think Arnott is wise in suggesting that investor revise their expectations down, just as he told my Foolish colleague Morgan Housel in December.

Are you at ease...or nervous? It's been a great five-year run for investors, with the Dow and S&P at or near all-time highs. Yet fears abound. When will the next downturn hit? Will political gridlock lead to portfolio-killing inflation? To learn how to protect your portfolio, click here for free guidance from the Motley Fool Pro Academy!


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