Probability of Recession: Back-of-the-Envelope Calculations

J.P. Morgan came up with a quick back-of-the envelope calculation for the probability of a recession, and determined that as of March 8th the U.S. equity market had priced in a probability of 50%.

Here’s how the math works: The average S&P 500 decline over the last 11 U.S. recessions was 26%. As of the date of the report, the S&P had declined 13%. “Thirteen divided by 26 produces a 50% recession probability.”

A recent article in Barron’s provided a quick calculation for the probability of a recession citing MacroMavens commentator Stephanie Pomboy. The logic stems from the idea recessions follow the simultaneous increase in long-term interest rates and oil prices. Per the article:

Over the past 30 years, the economy has headed south whenever the sum of the year-over-year change in Baa corporate bond yields, plus the change in oil prices, has topped 100%. That was the case in both the 2000-01 post-dot-com bust and the 2007-09 housing debacle.