Is No News Good News? News Sentiment and U.S. Recessions

Recessions are a painful part of the business cycle. They are associated with shrinking economic activity, rising unemployment, falling corporate earnings, and climbing corporate defaults. The prices of equities and other risk assets tend to drop in anticipation of a recession and continue to slump throughout its trough.

Predicting the timing of a recession to prepare for pullbacks in asset prices is a challenging endeavor. We gauge the likelihood of US recessions in a number of ways, including measuring the current sentiment about economic prospects through news articles,¹ and analyzing the stock market's reaction. We construct a recession news sentiment index that tracks negative sentiment (fear) based on published articles about the US economy. The sentiment index is computed on a daily basis and is scaled from -1 to 0². We plot the recession index below, along with the price return of the S&P 500 Index.

Figure 1: U.S. Recession Sentiment Index and S&P 500 Index

Figure 1 (above) shows that the recession sentiment index has experienced abrupt and clustered drops, reflecting the pattern of recession-related news attention that tends to come in bursts, leading to depressed sentiment that can decay very quickly.

Despite the uncertain Fed policy outlook amid bumpy US inflation data and geopolitical tension in the Middle East, recession sentiment in the US as of the end of April 2024 is mild relative to its history. While the signal's momentum, measured as the 12-month change in sentiment, remains relatively strong³ and is above one unit of its own standard deviation (Figure 2, below), the signal's recent moderation from +2 to +1 indicates concerns about slower growth.

Figure 2: Moderating Recession Signal Momentum Raises Concerns

As seen in Figure 1, falling recession sentiment often coincides with volatility in the US stock market. Interestingly, a decline in sentiment sometimes precedes market drawdowns. In examining the distribution of next-day returns⁴ of the S&P 500 Index, over the sample period (Jan 2003 - April 2024), we see that daily losses during periods of negative sentiment momentum are meaningfully worse than those when momentum is positive. This is reflected by the 1^st, 5^th and 25^th percentiles in Table 1 below.

Table 1: Daily Losses During Negative & Positive Sentiment Momentum

For example, the 1^st percentile of the next-day return is -5.20% when the sentiment momentum is lower than -1 standard deviation. The corresponding percentile is -2.61% when the momentum is higher than +1 standard deviation. In terms of the worst one-day losses, it is -11.98% in the low sentiment case, compared to a loss of -3.90% in the high sentiment environment. Negative sentiment momentum, which is associated with fat-tail and left-skewed distribution of returns as shown in Table 1, can help to evaluate recession risks on the horizon and position portfolios appropriately.

We find recession sentiment measures bring an alternative perspective to the analysis of US business cycle dynamics, and their potential application in asset allocation and risk management make recession sentiment measures useful tools for investors.

¹ News articles analyzed were supplied by Bloomberg Professional Services. Underlying news sources include Bloomberg News, The New York Times, other media providers, and web scrapes.

² Values closer to -1 indicate more depressed sentiment.

³ In Figure 2, we show the 12-month change in US recession sentiment divided by its own standard deviation, over the last five years. A positive change means an improvement in sentiment, i.e., a less depressed tone in the news about US recessions.

⁴ The next day return dataset of momentum > 1std (< -1std) subsumes that of momentum > 2std (< -2std).