Talk about the probability of a recession has increased of late as stocks have gotten hit. Mark Zandi puts it at 35%. Jeff Gundlach thinks it’s higher than 50%.

One thing I was taught is an important indicator of a potential recession is credit spreads – that is, the spread between high grade and low grade corporate bonds. That’s because a weak economy puts weak companies at risk of defaulting on their debt requiring a higher interest rates for investors to be willing to hold it. As you can see in the chart above from @MacroAlf, credit spreads have blown out in the last couple months. But you can also see that they blew out during the correction last July-August – and of course we didn’t have a recession.

The next thing to look at is companies reporting earnings whose fiscal quarter ended February 28, 2025, which gives us the latest month of business activity and anything management is seeing up to the present they might want to incorporate into forward guidance.

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The first earnings report that made me think one might be coming was by KB Homes (KBH) last Monday. New Orders dropped 17% and Deliveries 9% in the quarter ended February 28, 2025 compared to a year ago. KBH lowered full year housing revenue guidance to $6.6-$7.0 billion from $7.0-$7.5 billion. On the other hand, Lennar (LEN) didn’t see the same drop off when it reported its quarter ended February 28, 2025 on Thursday March 20 – though margins significantly squeezed profitability.

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On Thursday March 20, Federal Express (FDX) reduced guidance for its current fiscal year to revenue of flat to slightly down from flat and adjusted diluted EPS of $18.00-$18.60 from $19.00-$20.00, respectively, when reporting its 3QFY25 ended February 28, 2025. That created quite a candle from trading on Friday March 21. FDX is frequently thought of as an economic bellwether as shipments are a measure of economic activity.

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FDX’s report is notable in my opinion but by no means definitively suggests we’re heading for a recession. The same thing applies to reports by investment bank Jefferies (JEF) and athleisure maker and retailer Lululemon (LULU) last week.

JEF’s Equity Underwriting revenue fell 39% in the quarter ended February 28, 2025 compared to the year ago period, reflecting a dearth of IPOs. However, Advisory and Debt Underwriting revenue was quite healthy. LULU guided full year revenue growth to 7-8% compared to 10% in 2024 which was a little light but by no means recessionary. Both JEF and LULU stock got smashed in reaction to their earnings reports.

Obviously how the Trump Tariffs play out as well as the stance taken by the Fed matter a lot.

Whether we have a recession or not matters. If we’re just experiencing a nasty correction due to overvaluation and froth, the market likely won’t go down more than 20% so we’re almost there already. However, if we’re on the verge of recession that is going to slow the economy and crimp corporate earnings, stocks could get hit up to 40%.

Based on all the evidence just reviewed, I think the best estimate for the probability of a recession in the next few months is 50%. When 1Q25 earnings reports start rolling in in a couple weeks, that should give us the data we need to tip the balance one way or the other.

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