Wall Street Faces Economic Uncertainty Amid Recession Signals

Recently, Wall Street has had no shortage of catalysts, with the Dow Jones Industrial Average (DJINDICES: ^DJI), S&P 500 (SNPINDEX: ^GSPC), and Nasdaq Composite (NASDAQINDEX: ^IXIC) experiencing a rise over nearly two and a half years. This surge, fueled by advancements in artificial intelligence (AI), has kept investors engaged in 2025. Meanwhile, President Donald Trump’s shifting tariff policies, fluctuations in Treasury bond yields, and renewed enthusiasm for stock splits have added to the market’s complexity. However, it is worth considering whether Wall Street is overlooking the broader economic landscape of the U.S.

Though the economy and stock market do not always align perfectly, corporate earnings tend to correlate with the health of the domestic economy. One recession forecasting tool, which has a strong track record of accuracy since 1959, suggests the U.S. economy and stock market may not be as robust as they seem.

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Proven Recession Indicators and Their Accuracy

No forecasting tool can precisely predict the future of the U.S. economy or Wall Street. However, certain metrics have historically shown strong correlations with movements in major indices like the Dow, S&P 500, and Nasdaq Composite. A notable driver of economic downturns has been significant declines in M2 money supply.

Currently, the main concern for Wall Street seems less tied to tariff policies and more to what the Federal Reserve Bank of New York’s recession probability tool indicates about the future.

This tool evaluates the yield spread between the 10-year Treasury bond and the three-month Treasury bill to gauge the likelihood of a recession unfolding within the next 12 months. Typically, in a healthy economy, longer-term bonds yield more than short-term bills. A key warning sign occurs when this yield curve inverts, indicating that short-term yields exceed long-term yields, which generally signals investor anxiety regarding the economic outlook.

The only false positive for the New York Fed’s recession probability tool occurred in 1966. U.S. Recession Probability data by YCharts. Gray areas denote U.S. recessions.

As of May 2025, the New York Fed’s forecast indicated a 30.45% chance of a recession by April 2026. While this is an improvement from a high of over 70% in 2023—the highest rate seen in four decades—historical data shows that every probability above 32% since 1966 has eventually led to a recession.

Importantly, prior recessions did not materialize until after the yield curve was restored to a normal upward slope. This pattern, highlighted in the spread comparison of the 10-year and three-month Treasuries, reinforces the potential for an upcoming recession.

10 Year-3 Month Treasury Yield Spread data by YCharts. Gray areas denote U.S. recessions.

Given the recent steep inversion of the 10-year vs. three-month yield curve—the most significant in four decades—it’s reasonable to anticipate a delay in a correction towards normalcy. This adjustment, together with the New York Fed’s tool, suggests that a recession may indeed be on the horizon. Additionally, the first-quarter GDP reading indicated a 0.3% contraction, aligning with the possibility indicated by the Fed’s recession forecasting tool.

A study by Bank of America Global Research shows that around two-thirds of the S&P 500’s peak-to-trough drawdowns from 1927 to March 2023 occurred during U.S. recessions, not in advance of them.

Image source: Getty Images.

Understanding Economic Cycles and Investment Outlook

While it may be disheartening for investors to hear about a potential recession, these economic cycles are normal and expected phenomena. Though recessions typically bring higher unemployment and slower wage growth, they are usually short-lived; historically, the average recession in the U.S. since World War II has lasted just 10 months, without exceeding 18 months.

Conversely, periods of economic expansion tend to last around five years. This inconsistency between growth and contraction explains why, over time, the U.S. economy has displayed considerable growth.

This divergence of expectations is also reflected on Wall Street.

It’s official. A new bull market is confirmed.

The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.

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