“An error does not become truth by reason of multiplied propagation, nor does truth become error because nobody sees it.”
– Mahatma Gandhi
Once a month I like review my recession watch indicators. Why? In recessions bad stuff happens. Excesses in the system get corrected, defaults spike and the stock market declines approximately -37% on average. The last two recessions served up losses of more than 50%.
In this week’s piece, I quickly share with you what our recession indicators are signaling. In short, the news is good… there is no sign of recession within the next six to nine months.
Take a look at this next chart. I know it will seem busy and somewhat confusing at first but I’ll walk you through how to read the signals. What you are looking at is a summary of 10 different recession watch indicators. Some of the signals have a higher success rate than others, but what I like is how they combined the indicators and created a weight of evidence summary.
Here is how you read the chart:
- Listed are 10 “Early U.S. Recession Indicators.”
- Next to each indicator name is (trough) or (peak). That’s important as you look at the data horizontally to the right.
- The first data column shows the “Median” number of months before recession occurred from the peak or trough in the indicator.
- For example, the first indicator is the NDR Recession Probability Model. Take a look at how many months it’s been since the indicator troughed. In this case, it is one month since the trough. The “Median Lead Time from Trough to Recession” is 11 months. Now, this indicator could go on to set a lower trough but right now it is one month since the low.
- Next take a look the “Key Recession Level.” A recession signal would trigger when the “Current Level” score of 2.5 moves above 50. So this recession indicator is nowhere near 50. That’s good.
- Some of the indicators, like the NDR Recession Probability Model, look at many data points. I’m happy to walk you through each of the indicators if you shoot me a note. For now, don’t get hung up on how it works. Just focus on the score.
- You can go down the line and look at each of the indicators. Think of it as your “recession” dashboard. The idea is to get a 30,000-foot big picture view.
Send me a note if you’d like to dig deeper. For me, this is a pretty good way to gauge the probability of recession.
Bottom line: there is no sign of recession in the next six to nine months.
It is important to note that there is no perfect indicator. But I do believe that understanding where we are in the business cycle in a rules-based disciplined way can help us better understand periods of higher and lower risk. Should we play more offense than defense or more defense than offense? Getting in front of the challenges that recessions bring is important to our wealth.
The above list of 10 is great; however, not included is one of my favorite recession indicators, The Economy (The Index of Coincident Economic Indicators). The stock market is one of the best leading indicators for the economy. So my favorite indicator uses the trend in the stock market to signal coming recession or coming expansion. Historically, it has a high 79% accuracy rate.
Here is how you read the chart:
- Signals are marked by the up and down arrows
- Above some of the down arrows is a + or – sign followed by a number. For example, the -5 tells us that recession came five months after the signal. +2 tells us the signal came two months after recession started. Again, not perfect but pretty good.
- Some arrows (signals) were not followed by recession but they tended to quickly correct and stay in line with the direction of the economy.
- Now, here’s how the signals are triggered. The bottom section of the chart plots the S&P 500 Index (red line) and a five-month smoothed moving price average of the S&P 500 Index.
- Expansion signals are generated when the current price of the S&P 500 Index rises 3.6% above the five-month smoothed moving average price (a bullish trend for the market signals a coming or ongoing bullish trend for the economy).
- Contraction signals are generated when the current price of the S&P 500 Index declines by 4.8% below the five-month smoothed moving average price (a bearish trend for the market signals a coming or ongoing bearish trend for the economy).
Bottom line: the stock market is an excellent leading economic indicator. It is currently signaling “Expansion.” There is no current sign of recession.
If you are wondering what might kill the current economic “mojo,” it’s likely rising interest rates. Every recession since WWII has been preceded a Fed tightening (raising the federal funds rate). Remember how Greenspan’s and Bernanke’s easy money, low interest rate policies lead to excesses in the system (e.g., real estate in the 2008 crisis)? Raising rates is one of the levers the Fed uses to attempt to control the economy. Lower rates lower the cost to cover your debt (refinance your mortgage at a lower rate and more money goes into your pocket). You have more to spend. Raise rates and you have less to spend.
To cool off the economy in order to prevent inflation, the Fed raises rates. Debt financing becomes more expensive. The economy cools. Global debt relative to what the world produces (as measured by global GDP) is above 290% of debt-to-GDP (see last week’s OMR post). Risk of a Fed policy mistake is high. Rates are rising and the implications may well be summed up in a recent WSJ article, “Bond Selloff Sends Ripples Through Corporate-Debt Market.” Companies are paying higher rates when they sell bonds; outside the U.S., some put off debt-issuance plans. But it is also credit cards, auto loans, student loans and margin debt. All are near or at record levels. So we must be on guard for a change in the economic trend. We must protect our portfolios from the bad stuff that happens in recessions.
Finally, what many believe is the single best recession indicator is something called the “inverted yield curve.” Simply put, when short-term yields are higher than long-term yields, a recession typically follows. We are trending towards an inverted curve but not yet there.
“…[N]or does truth become error because nobody sees it.” Forward we set our sights. Let’s keep “Recession” on our radar.
Grab a coffee and click through. You will find the most recent Trade Signals and also I share a few photos from my ski trip in Utah. We skied the backcountry and the avalanche risk was moderate to high. We were led by three professional guides and one, our self-described spiritual leader, was a man named Craig. He is the head of the State of Utah’s Avalanche Center. Each run was a powder run and we were limited to slopes of 35 degrees of pitch or less (less risk of a slide). We all wore beacons and the guides are well trained and carry shovels just in case there is an accident. Don’t tell my wife that one of our friends triggered a slide (picture below). No one was injured but it did keep us on our toes.
Included in this week’s On My Radar:
- Trade Signals — Equities March On But We Watch Inflation
- Personal Note — Powder Skiing and the Super Bowl
Trade Signals — Equities March On But We Watch Inflation
S&P 500 Index — 2,837 (01-31-2018)
Notable this week:
Equities have had two days of indigestion. Nonetheless, the bullish trend persists for equities. The Federal Open Market Committee (FOMC) concluded its two-day policy meeting and held current rates steady.
The Don’t Fight the Tape or Fed moved from a 0 (neutral) reading back to a bullish +1 reading. The Ned Davis Research CMG U.S. Large Cap Long/Flat Index remains 100% invested in large-cap equities. The Zweig Bond Model remains bullish on fixed income and HY remains in a buy signal.
We continue to monitor our inflation and recession indicators. Despite extremely high valuations of equities, the trend evidence is stretched yet still bullish.
Long-time readers know that I am a big fan of Ned Davis Research. I’ve been a client for years and value their service. If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at 617-279-4876. John’s email address is [email protected]. I am not compensated in any way by NDR. I’m just a fan of their work.
Click here for the latest Trade Signals.
Important note: Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note — Powder Skiing and the Super Bowl
I’m writing this week from an investment conference in Park City, Utah. Arriving a day early, yesterday found me skiing the backcountry for the first time. One of the attendees owns property and the conference host hired several professional guides. We skied our friend’s big mountain property (his grandfather bought 10,000 acres in the 1930s).
It was a day of endless private powder (pictures below). If you’ve never skied powder before, it’s hard to describe the feeling. It’s like flying in the air with your feet on the ground or floating on a soft cloud. You hear little; you get lost inside and you rock from side to side as you float down the mountain. I always tell my kids that I wish we could bottle up the feeling and sell it to the world. We’d have more peace. It was a wonderful day, but to say I need to get my fitness up is an understatement.
And here is the picture of the avalanche that was triggered.
The Super Bowl
This Sunday I’ll be glued to the TV. Susan and I are hosting a Super Bowl party and our family is crazy about the Philadelphia Eagles. Brianna is home and the boys are inviting a few friends.
I had a little fun with a Boston friend this week. Fortunately, I was able to find a green towel to drape over the New England Patriots banner hanging outside his Salt Lake City house. Click HERE for the very short video. The City of Brotherly Love. Well… kind-of. One last graphic for today:
My grandfather and my father were die-hard Eagles fans and, of course, I am as well… and now our kids. Our fingers are crossed.
Have a wonderful weekend.
With kind regards,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.