Recession risk rising, low returns ahead: Street

Published Fri, Sep 25 20158:07 AM EDT

Quantitative models for forecasting recessions are sending warning signals, suggesting low returns for risky assets are ahead, JPMorgan told clients this week. "Current levels of recession risk predict below-average returns on equities and widening corporate spreads," JPMorgan economist Jesse Edgerton wrote on Wednesday. "At face value, these forecasts would suggest that asset allocations should begin to shift away from equities." Wall Street firms such as JPMorgan rely on quantitative models to assess the probability risk of economic events and determine asset locations. At the current levels, the investment bank sets the probability of a recession at 40 percent within the next two years and over 50 percent within three years, Edgerton said. Based on the recession risk estimate, JPMorgan's quant team predicts an expected return on equities of only about 4 percent within the next 12 months. In a CNBC Pro interview this week, hedge fund manager Brian Kelly also alluded to the notion of a "global recession" that will likely spread to the U.S., forcing policymakers to adopt ongoing economic stimulus measures. In the past month, fears of slow global economic growth, particularly in emerging markets, sent equity benchmarks into correction and bear market territory with indexes in the U.S., Canada, France, Germany, China, Brazil, Russia and elsewhere down 10 to 35 percent from their 52-week highs. Source: FactSet Apart from recessionary risks, domestic stocks face stretched valuations, according to Jack Ablin, chief investment officer of BMO Private Bank. "Notwithstanding the recent pullback, U.S. equities remain expensive by historical standards," said Ablin, explaining that the S & P 500 is trading at 16 percent above its historical median value, when gauged against revenues. "At the same time, revenue and growth estimates are slowing," he said, pointing to analysts' expectations of a 3 percent decline in revenue for the third quarter in 2015. A statistical analysis from BMO Private Bank shows that the S & P is projected to return about 3 percent per year for the next three years, when adding dividends into the mix. Source: BMO Private Bank To be sure, like any other statistical tool, JPMorgan says that prediction models are subject to considerable uncertainty. "Nonetheless, our results illustrate that history suggests it may be time for both economists and investors to start thinking about the next recession," Edgerton said. Read More Top managers on where to hide amid volatile market

Traders work on the floor of the New York Stock Exchange.

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Quantitative models for forecasting recessions are sending warning signals, suggesting low returns for risky assets are ahead, JPMorgan told clients this week.

"Current levels of recession risk predict below-average returns on equities and widening corporate spreads," JPMorgan economist Jesse Edgerton wrote on Wednesday. "At face value, these forecasts would suggest that asset allocations should begin to shift away from equities."

Wall Street firms such as JPMorgan rely on quantitative models to assess the probability risk of economic events and determine asset locations.

At the current levels, the investment bank sets the probability of a recession at 40 percent within the next two years and over 50 percent within three years, Edgerton said.