There is no shortage of questions swirling around the Street and Americans’ dinner tables: Are we in a recession? When will prices go down? Is my house going to be worth a lot less in a couple of months? Has the stock market bottomed yet?
Everyone is searching for answers. Despite a few up days in the markets, sentiment overall remains fearful: Stocks fell into a bear market in 2022, with the S&P 500 20.2% since the start of the year; and despite a strong jobs market, the ever-mighty consumer has shown some signs of weakness of late amid nosebleed inflation, with consumer spending coming in soft in May.
Calls for a recession—whether we’re currently in one, are heading that way, or will avoid it altogether—are echoing on Wall Street and beyond. And there are a lot of mixed signals.
To that end, Fortune sought out top economist Mark Zandi, the chief economist at Moody’s Analytics, to answer all the burning questions about the stock market’s path, whether or not we’re headed for a recession, and what’s ahead for the housing market.
This Q&A has been edited and condensed for clarity.
Why does this economic moment in time feel so weird?
Zandi: We’re dealing with two massive, unprecedented, out of the blue shocks to the economy: The first is the pandemic, and the second is Russia’s aggression in Ukraine. It’s a marvel that the economy has been able to keep moving forward despite having to grapple with these two shocks, and they’re global shocks.
I think what makes this period in economic history so difficult to interpret is because it’s just so unusual—it’s because of two things that are very unpredictable.
You recently penned an op-ed titled: “What economists like me got wrong about inflation”. How bad is the inflation picture right now? Are we starting to see disinflation? Do you imagine we’ll see it getting worse?
A lot depends on the pandemic and the path of the Russian war, but my sense is that we are past the worst of the inflation.
The surge in inflation has been predominantly because of the high oil and commodity prices due to the Russian war and the supply-chain issues related to the pandemic. If those things are winding down, or at least moving in the right direction, that’s going to take a lot of steam out of overall inflation. We’ll see disinflation for gas prices, disinflation for vehicle prices—that’s going to put significant downward pressure on overall inflation.
Most importantly and most immediately, oil prices have come down very significantly. We’re…way down from where it was at its worst when the European Union announced it was going to sanction Russian oil a couple of months ago…That is very important to inflation and the economic outlook avoiding recession.
The supply-chain issues that have been caused by the pandemic seem to be ironing themselves out slowly, but it’s happening. Demand is shifting away from the goods we bought during the pandemic to other things like travel and going to baseball games. So I feel prices starting to weaken on the goods side of the economy, and I expect them to start falling, particularly for vehicles, which has also been key to inflation.
I’m very reticent to say, just because timing all of this has been difficult month to month, but it feels like inflation is about to roll over in a very significant way here. [Inflation came in hot for June, with prices rising 9.1% year over year.]
Do you think we’re currently in a recession? And if not, when might we be in one?
No. I mean, how can the economy be in recession when we’re creating so many jobs? It’s just nonsensical…Two quarters of GDP [gross domestic product] declines is a good rule of thumb, but that is not the definition of recession.
It’s a broad-based, persistent decline in economic activity…It’s got to be for a while, [with] very clear declines in activity. And that’s not what we’re observing, at least not so far…[The National Bureau of Economic Research, the group that officially dates recessions] looks at a wide range of indicators. Right now, they’re all suggesting the economy is slowing, but it’s not contracting. It’s certainly not a recession. Now, having said that, because sentiment is so fragile, if anything else goes wrong—even perhaps a little thing could unnerve people—they could run for the proverbial bunker or stop spending; businesses stop hiring and start laying off; then you could actually go into recession.
If jobs start to decline, that’s proof positive that we’re in a recession. I think the earliest that could happen would be towards the end of this year going into next…It feels like if we’re going into recession, we’re going in by the end of the year—it’s not going to be by this time next year.
How long do you imagine a recession would last, and do you think it would be severe or mild?
If inflation rolls over, then I don’t think there’s any reason why we need to go into a recession, and if we did—just because something else goes wrong or the Federal Reserve pushes too hard on interest rates and misjudges—it should be short-lived and modest because there’s no significant structural imbalances in the economy that typically are evident prior to recessions. Leverage is low. Household debt is low. Corporate debt is low. People have locked in these previously low interest rates.
Real estate markets are, if anything, under-supplied, particularly in the housing market. There’s no overbuilding that typically prevails prior to recession. The financial system is on incredibly solid foundation.
What should we expect if we do see a mild recession in 2022?
At worst it would be six to 12 months. It would be, we lose 3 million to 4 million jobs; it would be, unemployment peaks out at 5.5%, 6%. Inflation would come in pretty rapidly, if that were the case.
We often hear that corporate balance sheets are in good shape. Is that still the case, and how would that impact the likelihood or severity of a recession?
If you look at the corporate sector in aggregate, it looks good. Leverage has been rising but very consistent with growth and profitability and assets. Nothing looks untoward.
Profitability has been very strong. Margins have started to come in a little bit, but by historical standards, they’re extraordinarily wide…That would mean they won’t have the same kind of financial pressures to cut back on expansion plans and certainly on jobs…[Companies know] their biggest problem, long run, is finding workers, and they’re going to be reluctant to reduce their payrolls because they know two years from now, they’re going to be back trying to hire these folks again.
What’s driving the stock market selloff?
The most important thing is interest rates. It’s a repricing of all assets because interest rates are higher. When you go from record low to just normal interest rates close to what you would expect in the long run, earnings multiples are going to compress. So of the 20 percentage-point decline in the equity market, I’d say 15 percentage points is nothing but interest rates.
The other five percentage points is slower growth, and I don’t think the market is discounting recession at this point. It’s just a normalization of price to earnings multiples.
The market has embedded in it now these expectations of the Fed raising rates a lot over the next year…The high point in the funds rate, according to the Fed, is 4%. That’s what they are telling the market, and presumably the market says, “Yeah, I believe you.”…If we get there, then okay, the market’s already reflected that. But I’d be surprised if we even get there, if I’m right about inflation and inflation expectations. If that’s the case, then the market is probably pretty close to a bottom right now.
If we go into recession, it’s got another leg down, probably another 10 percentage points.
Care to predict when the market might recover?
I don’t think it rises anytime soon, because it has to work through everything…and make sure that we don’t go into an actual recession…But I don’t think it goes any lower.
If you’re an institutional investor or you are an active investor, I would think this is a pretty good time to start buying in.
The yield curve has been inverting recently. What’s that telling us?
If it inverts by a few basis points for a few days, a few weeks, I don’t think it’s signaling much of anything. It’s signaling the economy is going to be weak, but not recessionary. You need a harder inversion, like the 10-year and two-year inverted by 25, 30 basis points for a month or two. That’s a clear signal. And if that’s the case, then I’ll be wrong, and we’ll go into recession, and the market will go down another 10 percentage points.
Bonds clearly haven’t been a good investment for most of the year. How do you see things playing out with yields in the coming months?
I don’t think I’d be going into bonds now. Just like stocks, it’s hard to see that happening with the Fed kind of on the warpath. And I don’t think long-term interest rates, 10-year yields, are back to where they need to be, long run.
I’d be less enthusiastic about bonds at this point, [but there’s] nothing wrong with buying short-term bonds, near-term bonds.
Should investors be worried about the state of the economy? We are seeing slowing growth, but do you see positive signs here?
I think recession risks are obviously very high, and the economy is very vulnerable—sentiment is very weak. It will take another significant event to push us under. I think it’s important not to be Pollyannaish about this, but I do think people are overly pessimistic. They’re assuming recession, even if nothing else goes wrong, like, “This is inevitable that we’re going in,” and I just think that is way too pessimistic. There’s too many good things that are happening that argue that that won’t happen. Fundamentally, the firewall between an economy that continues to grow, albeit slowly, and a recession is the American consumer, and the American consumer is in good financial shape: lots of jobs, lots of excess saving, low debt burdens.
You recently predicted that lower-income households have about six months before their savings run dry at this rate. What’s the state of the consumer right now?
The state of the consumer is very good…Stock prices are down, but housing values are up. Net of all that is wealth today is about where it was a year ago, but it’s way up from where it was three, five, 10 years ago. So you look at the consumer broadly, they’re sitting in a very good financial position. The only problem is inflation. That is cutting into real incomes. And so consumers have a choice: They either pull back their spending because of their lower purchasing power, or they supplement their income with their extra savings and continue to spend at a pace that they have historically. I think they do the latter.
Complicating the interpretation of what consumers are doing is this massive shift in what they’re spending their money on. It makes it very difficult to gauge exactly how things are going because it depends on which part of the consumer elephant you touch. If you’re focused on the retail goods side of spending, it looks soft: Target, Walmart. If you look at the service side of what consumers are spending on—travel, recreational activities, eating out—it looks good…But if you add it all up, consumers are spending at a pace that is precisely consistent with where you would expect them to be if there had been no pandemic.
Consumer spending has been slowing in recent months. Do you see that continuing, or do you think it’s just a blip?
I think we need to step back from the month to month data, and it looks to me like spending is right on track to where it needs to be to keep the economy recession-free. The consumer is conflicted because they’re paying so much more at the gas station and grocery store and for their rent, so if they didn’t have that excess savings, then they’d have to pull back on their spending. But because of that excess savings, they’re able to use that. They don’t like doing that…but I think they will if push comes to shove.
How would we know if we’re in stagflation? Do you see that as potentially happening this year?
Right now, you’ve got the high inflation, but you’ve got low unemployment. You’d have to see unemployment start notching higher here in a meaningful way. To me, stagflation would have to be at least persistent 4% inflation and 4% unemployment. If we saw [that],…that would be a sign that stagflation is more of a problem. But as soon as that became evident, I think we’d be quickly in a recession because the Fed would go on the warpath.
What is the outlook for real estate and the housing market? You’ve said that we’re in a “housing correction.” Where could that take us moving forward?
The housing sector is the most interest rate–sensitive sector of the economy. The Fed is working to keep inflation expectations down and to slow the growth in the economy so that it doesn’t blow past full employment and inflation becomes worse. So that means housing has to struggle, has to suffer—it’s gonna feel it. And it is. We’re seeing it clearly in home sales and housing demand, and the next place we’ll see it will be in house prices as home sellers ultimately give up and start marking down their list price, and we’ll see prices nationwide go flat, I think.
If it goes flat for the next couple, three years, that means a fair number of markets are going to experience price declines, mostly in the South and the West, where prices have been the most juiced up. That assumes no recession. If we do get a recession—the typical downturn—then I think we will get some national price declines: 5% down, peak to trough, something like that. But the most likely scenario in my mind remains that prices essentially just flatline here for the next two, three years as the market adjusts to these higher mortgage rates.
We should start seeing some flattening out in price certainly this fall, towards the end of the year.
What sectors or industries do you imagine would be hardest hit if we did have a recession in 2022?
Anything construction related, housing related, real estate related, both on the residential side and on the commercial side…Manufacturing typically gets nailed; that’s interest rate sensitive…Anything commodity-related, mining…Ultimately the industries that cater towards a discretionary consumer: leisure, hospitality, restaurants, recreational activities, travel, elective health care, financial services—they’ll all start to see weakness.
How do you imagine geopolitics and the Russia-Ukraine war will affect the U.S. economy moving forward?
The key link is through oil prices. I think we’ve seen the worst of that, because anyone who’s going to sanction Russian oil has done it…If there’s some disruption from Russian oil to China and India—because a lot of oil is going in that direction—if that got disrupted for whatever reason, and oil prices jumped again, that would be a problem. If we go back to $125 a barrel, where we were a couple of months ago, and gas prices head back towards $5 and over, I think it’d be hard to avoid a recession at that point.
What’s one thing that makes you optimistic and one thing that makes you worried about the economy right now?
What worries me the most is that people are so worried—we can talk ourselves into a recession. The thing that makes me most optimistic goes back to the key to all of it: It’s the American consumer, who continues to drive the economic train, not only here but globally. As long as the American consumer hangs tough, and everything suggests that she should, the economy should avoid recession.
