It’s that time of the year when economists and market mavens spill an abundance of ink making year-ahead stock forecasts and boom/bust warnings. As there seems to be an abnormal amount of recession predictions for the year ahead—including a few from some reputable sources—I think we should examine the question: Will the U.S. witness a major economic shock in 2026?
Wall Street economists tend to be a conservative lot, and as such, tend to shy away from predicting recessions (that is, unless the economic indicators are too atrocious to avoid using the “R” word). Right now, I’d say that most of the metrics economists use to divine the six-to-12-month outlook are in good-to-decent shape, although there are a couple of exceptions.
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Most notably, the employment rate is showing some signs of deterioration. Job growth is slowing as we head into the year’s end, with total nonfarm payroll employment showing little change since April. And according to the latest ADP National Employment Report, the U.S. private sector actually shed 32,000 jobs in November, which was the biggest drop since March 2023.
What’s more, layoffs and layoff warnings have hit their highest levels in a decade (particularly in manufacturing, business/information services and construction), while the official unemployment rate has increased over the second half of the year, reaching 4.4% in September—its highest level in four years.
But since the metrics published by the Bureau of Labor Statistics and the National Bureau of Economic Research can take up to a year after a recession actually starts to formally identify it, the search for early warning signals is relentless. That’s where the widely watched Leading Economic Index (LEI) published by the Conference Board enters the picture.
The LEI has traditionally been an accurate recession warning gauge, and alarmingly, it flashed a recession signal when it declined by nearly 3% between February and August, slipping below the level that historically presages the onset of recession. (As an aside, this year’s tariffs were partly blamed for the economic deterioration reflected in recent LEI readings.)
Source: The Conference Board
To be fair, recessions are notoriously difficult to predict with any accuracy, with the old bromide that “economists have correctly predicted 22 of the last nine recessions” coming to mind. And to quote a particularly jaded (unnamed) pundit, “This is the longest recession prediction ever to never come to fruition—three years and counting!” As this sentiment implies, betting that a recession comes to the U.S. in 2026 can be regarded as something of a statistical improbability.
Putting aside the putative value of the LEI, another, more reliable recession indicator was devised by the Richmond branch of the Federal Reserve. It’s the Scavette-O’Trakoun-Sahm-style recession indicator (“S.O.S.” indicator for short), and it’s based on the insured unemployment rate. In the words of the Richmond Fed, “The weekly S.O.S. indicator has been demonstrated to provide accurate and timely signals of recession over the past fifty years, and may complement the signals of other leading recession indicators.”
The S.O.S. indicator is based on hard data, specifically, continuing unemployment claims (approved jobless benefits). By contrast, the official monthly unemployment rate is based on a household survey of what people say, which at times can be a poor reflection of economic reality.
Source: Richmond Fed
As it now stands, with continuing claims having reached nearly two million, the S.O.S. indicator is halfway to triggering a classic “recession” signal…which is also another way of saying it’s halfway to NOT triggering such a signal. But for the benefit of the recession hawks, if the current rate of change in the S.O.S. continues, a recession signal would likely occur in February, or March at the latest.
As for me, while I’m not dogmatic enough to make an official prediction, I tend to favor the dovish outlook that the U.S. economy will once again weather the unemployment storm and dodge a recession next year. My personal indicators for discerning the state of the economy are strictly equity market-based (using Ed Yardeni’s maxim that “recessions cause bear markets,” which implies that any economic deterioration will quickly manifest in stock prices).
That said, I currently see no evidence that Mr. Market is worried about a recession in the foreseeable future. The economically sensitive banks (including regional banks) and broker/dealer stocks still look good, while the even more interest rate-sensitive equities are showing a fair degree of strength.
However, in the event that a recession does rear its ugly head in 2026, I’m confident we’ll get a “heads-up” signal in the market (chiefly in the form of conspicuous underperformance in the economically sensitive bank and broker/dealer stocks) that will give us sufficient time to prepare. More importantly, I believe the Cabot Turnaround Letter portfolio is fairly well positioned for even a harsh economic climate, given its somewhat limited exposure to cyclical stocks and strong exposure to defensive-oriented issues.
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