“…the Fed has typically tightened too much and/or for too long.
From this long history, a well-established pattern is identifiable.
The economic growth rate along with inflation receded.
A financial crisis was more likely than not.”

– Van R. Hoisington and Lacy H. Hunt, Ph.D.

Many years ago I created an economic investment dashboard of sorts to help me do my best to keep my head screwed on straight.  If you subscribe to a handful of research services, you know what I mean.  For every 10 bulls, there are 10 bears.

When I was a young Merrill Lynch financial consultant, in addition to ML’s research, I subscribed to over a dozen investment newsletters.  I found myself spinning in a sea of mixed messages.  My manager thought I was nuts.  Perhaps he was right. Think of the research we now have at our fingertips.  Really cool; but frankly, exponentially more confusing.  It’s easy to get emotionally pulled off-sides.  So it’s the dashboard for me.

On the dashboard, among other data inputs, are my favorite recession indicators and an inflation indicator chart. Depending on how your portfolio is positioned, both events will impact your net worth (favorably or unfavorably).  Today, you’ll find below several recession prediction charts.  You’ll see that I highlight in red (bad) or green (good) the checklist of things I follow based on the current state of each indicator.

I believe the recession watch charts are the most important.  Why?  We get one to two each decade, the last was in 2008 and we are due.  Why?  Because that is when all the bad stuff happens. Defaults rise and stock markets decline 40% or more.  You’ll see below that the good news is the current probability of recession is low.

You can find my dashboard every Wednesday afternoon in the Trade Signals research page on our website.  I also provide a link for you each week in On My Radar (link below).  Note, I’m a trend follower so you’ll find a lot of trend-based indicators as well.

But before you jump into the recession data, I want to share something I feel deserves your attention.  One letter that is a must-read is the quarterly investor letter from Van Hoisington and Dr. Lacy Hunt.  I know of no one else that understands Fed policy and history better.  So before you view the recession probability charts, let’s take a look at what they have to say about the Fed.  They believe the Fed is leading us right into the next recession. Their insights and my charts tie together.

What to watch for?  This from Van and Lacy:

The Federal Reserve has initiated the fifteenth tightening cycle since 1945. Conspicuously, in 80% of the prior fourteen episodes, recessions followed, with outright business contractions being avoided in just three cases.  What is notable today is that the economy is in the 93rd month of this expansion, a length of time that is well beyond periods in prior expansions where soft landings occurred (1968, 1984 and 1995).  This is relevant because the pent-up demand from the prior downturn has been exhausted; thus, the economy is extremely vulnerable to a shock, which could lead to recession.

Regardless of whether there was an associated recession, the last ten cycles of tightening all triggered financial crises.  In conjunction with the non-monetary determinants of economic activity (referred to as initial conditions), monetary restraint served to expose over-leveraged parties and, in turn, financial crises ensued.

Fear not, my good friend.  Just put in place a plan that enables you to risk manage what you’ve got.  The last two recessions found the stock market declining by more than 50%.  What aging, baby booming (me included) pre-retiree or retiree can afford to take that hit?  On average, think -40% during recession.

The last recession was in 2008-2009.  There has been no decade since the year 1850 where we did not get at least one recession.  Can this decade break the trend?  I doubt it.

Because recessions are only officially known in hindsight and after all the bad stuff happens, we have to do our best to get in front of them.  Thus, my recession obsession.  To that end, today you’ll find my favorite recession watch charts in the Charts of the Week section below along with an explanation of how they work.

But first, read what Van and Lacy have to say.  I share several highlights in bullet point form and provide a link to the full letter.

Read on…  and have a wonderful, long holiday weekend!

? If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ?

Included in this week’s On My Radar:

  • Fed Tightening Cycles – Past and Present, by Van R. Hoisington and Lacy H. Hunt, Ph.D.
  • Charts of the Week
  • Trade Signals – Low Risk of Recession Risk, High Risk of Inflation, Equity Trend Remains Bullish
  • Personal Note

Fed Tightening Cycles – Past and Present

Following are my high level notes from Hoisington’s quarterly letter:

  • Four important considerations exist today that were not present in past cycles and that may magnify the current restraining actions of the Federal Reserve:

(1) The Fed has initiated a tightening cycle at a time when significant differences exist in the initial conditions compared to the initial conditions in prior cycles. Additionally, the Fed is tightening into a deteriorating economy with last year’s growth in nominal GDP worse than in any of the prior fourteen cases.

(2) Business and government balance sheets are burdened with record amounts of debt. This means that small changes in interest rates may have an outsized impact on investment and spending decisions.

(3) Previous Federal Reserve experiments, primarily the periods of quantitative easings, have led to an unprecedented balance sheet (an action of “grand design”) to which the economy has grown accustomed. The resulting reduction in that balance sheet (reduction in the monetary base) may have a more profound impact on growth than anticipated.

(4) The monetary base reduction and the impact of the changing regulatory landscape, both in the U.S. and globally, has meant a significant increase in the amount of liquid reserves that banks are required to hold. Liquidity may have already been sharply restrained by the lowering of the monetary base, despite its massive $3.8 trillion size. This is evident as the monetary and credit aggregates are following the expected deteriorating pattern resulting from monetary restraint, suggesting recessionary conditions may lie ahead.

SBB: Here’s more… then Van and Lacy’s conclusion.

  • Several factors that influence the economy (other than monetary policy) are far more problematic than those that existed in any of the prior tightening cycles. For instance, the U.S. is experiencing the weakest population growth since the 1930s and the lowest fertility rate since the records began. There has been a slowdown in the growth rate of household formation, and the U.S. has a rapidly aging society.
  • For the full calendar year 2016, nominal GDP rose just 3.0%, the weakest reported since 2009. Last year’s growth rate was even less than the cyclical lows associated with the recessions of 1990-91 and 2000-01.
  • Despite the lowest annual economic growth rate of this expansion and the second straight year of declining growth, no fiscal stimulus is expected for 2017.
  • Monetary restraint implemented in late 2015 and 2016 has been followed by further restraint in 2017. How
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