Recession Will Sink S&P 500 by 40%, Economist Says

Legendary economist Gary Shilling says the US economy is headed toward a recession — that is, if we’re not already in one.

“It’s probably starting now, maybe it’s already started,” Shilling, who has worked as an economist at institutions like the Federal Reserve and Merrill Lynch, told Insider this week. 

His main argument for why a downturn is in store is the Fed’s dedication to getting inflation back down to its long-term goal of 2%. Currently, the Consumer Price Index sits at 3.7% year-over-year, while core CPI, which does not capture volatile food and energy prices, is at 4.3%.

Interest rates work to slow the economy by making auto loans, mortgages, credit card debt, and business loans more expensive to take on. This slows demand, therefore theoretically slowing inflation, but often at the cost of profits and jobs. 

Fed officials have repeatedly stated their intentions to get inflation back down to their target, and markets are betting they won’t cut rates until well into next year. 

“The Fed wants to make sure they’ve killed inflation,” Shilling said.

Shilling, who called the 2008 recession, pointed out that recessions sometimes don’t start until the Fed has already begun to cut rates. Rate hikes operate on a lag, taking time to fully impact the economy. According to the economist David Rosenberg, 80% of the Fed’s hiking cycles end in a recession.

fed funds rate

The Federal Reserve Bank of St. Louis

Trusted recession indicators are also signaling that a downturn is coming, Shilling said. One of them is the Treasury yield curve. Every time the curve has inverted since the 1960s, a recession has followed. 

An inversion happens when short-duration yields rise above longer-duration yields as a result of both a rising fed funds rate and investors piling into safe-haven assets like the 10-year note as they grow concerned about the economy’s health.

Here’s the spread between 3-month and 10-year yields. An inversion occurs when the spread dips below zero. 

yield curve

Federal Reserve Bank of St. Louis

Another indicator Shilling pointed to is the The Conference Board’s Leading Economic Index, which bundles 10 indexes on things like manufacturing activity, lending activity, bond-market performance, stock-market performance, consumer outlooks, and…

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