fbpx

Recession Update: If the US Economy is Slowing, is a Recession Coming?

Central bank chairmen on both sides of the Atlantic are saying that they will do whatever it takes to continue the current economic expansion, which has run for 120 months, a record, and by all rights should end. President Trump is calling his Fed Chairman an “idiot” for destroying his economic success story and possibly his re-election bid in 2020, although his stimulus programs failed to deliver on promises and his inept trade tactics could drive the global economy into recession. All rhetoric aside, financial markets are edgy. Will the next 18 months witness a recession?

DP-Based-recession-indicator

Before diving into the economic detail, there are a few facts that require our general acknowledgement up front. We are in an economic expansion, not a recovery. We have long since passed many old plateaus, if you will. We are currently and have been expanding, and all expansions eventually end in recession, no escaping that one. Fed models predict GDP growth at roughly 2% over the next twelve months, not great, but not a negative downturn. The Econbrowser Recession Indicator Index, shown above and created by James Hamilton, an economics professor at UC San Diego, pegged the probability of a recession in Q1 of 2019 as 2.4%, not exactly bone-crushing odds.

Yes, we are experiencing what central bankers have “gerrymandered” on our behalf, a “new normal”, where growth is gradual, somewhat boring, but nothing to be afraid of or to write home about either. The games played with monetary policy and quantitative easing have resulted in an economy that, at least in developed nations, is incapable of hitting inflation targets, no matter how much stimulus is thrown at it. For these same reasons, experts have warned that none of our previous models, technical analyses, or favorite charts are worth the paper they are printed on – everything is up for grabs.

As discouraging as this situation might sound, we can still go through a step by step analysis to remind ourselves of why economists are such lousy forecasters when it comes to predicting recessions, why and what causes expansions to suddenly end, and what are a few creditable recession models saying about the next 18 months, if 12 months really is to be accepted as steady as she goes.

Why are economists such lousy forecasters when predicting recessions?

We rely a great deal on professional economic forecasters to predict growth, an ability that has been proven over time to be within acceptable limits. Economists, however, fail when trying to pinpoint when recessions will start. Their track record is abysmal. Per one analyst: “For example, look at the predictions made in February 2008. The consensus forecast for real GDP in 2008 was +1.8%; actual was –0.1%. Their forecast for 2009 was +2.8%; actual was –2.4%. The recession had begun in December 2007.”

One of the almost laughable quotes cited in this area was when Ben Bernanke told Congress at the end of 2007 that there were no signs of recession on the horizon. NOT! Part of the problem is that the degree of error in the collection of economic data is more than you might think, the reason why the previous two quarters for important data points are always revised after more time is allowed to get the full picture. The December 2007 recession was not officially declared to be so until quarters after the fact, the same reason why the forecasts made by many recession models are suspect.

Many articles have appeared in the financial press over the past year or so about how creditable an inverted yield curve is as an accurate recession predictor. But which securities do you pick, and when will the recession happen? There are several pairs of U.S. Treasuries that have recently experienced inverted yield curves of late, but the accuracy of the prediction is generally stipulated to be between 12 to 18 months after the inversion takes place. While models might be uncertain, the fact that all expansions must end in recession is certain. If yield curves are right, then 18 months is the timeframe.

The need to know when the business slowdown will kick in big time is necessary in order to plan and line up resources to cushion the blow, revive the economic engine, and start the recovery. Experts this time around have two concerns. First, central banking restraints on natural market forces are so entwined and global markets are so inter-connected that all bets are off as far as previous models and charts go. Previous behavior cannot serve as a good guide. Second, central banking “tool boxes” are nearly depleted, and deficits are running extremely high, due in part to Trump’s foolishness. There is very little “powder in the monetary/government keg” to ignite a new jumpstart.

Why and what causes expansions to suddenly end?

Whether we like it or not, business cycles include both expansions and recessions, the latter, which, if it turns severe, can be labeled as a depression. No government agency has been assigned the task of declaring a depression, but a general definition is that it is either a recession that lasts for two years or GDP growth declines by 10% or more. In any event, the advent of the Fed and monetary policy tools have greatly reduced the propensity and severity of economic downturns, a good thing.

Having said that, the last economic downturn was labeled “The Great Recession”, which was more stubborn than most, primarily because it originated in the global banking system. The financial crisis had several causes, all working in tandem to produce the train wreck that occurred. One list of probable causes for a loss in confidence and subsequent downturn includes “trade wars, real wars, monetary policy (excessive rate increases by the Fed, restrictions on lending, breaking growth of the money supply), fiscal policy (large cuts in spending, large tax increases), and popping of big investment bubbles”.

Thanks again to proactive central banks and government spending programs, the number of recessions over a given time period have been reduced, and post WWII, the causes have fallen primarily into two categories:

  • The Fed raises interest rates too quickly to prevent “overheating” in the economy. Much has been written this time around that the Fed’s Normalization Policy would naturally bring about a “dreaded” recession. The “overheating” aspect can be rapid inflation across the board or wage related inflation;
  • Imbalances in the marketplace are the second major contributor, which can mean anything from excessive borrowing to the formation of sector “bubbles” in the tech community or in real estate prices.

We appear to be stretching the boundaries in both of these areas, the reason for the immediate concern within the economist community.

What are a few creditable recession models saying about the next 18 months?

Stock markets are never good predictors of a recession. A “crash” does not necessary correlate with an economic business downturn. Goldman Sachs, however, has taken data one step further to create what it calls a “Bear Market Indicator”. Its peaks have preceded recessions, as depicted below, and by the way, we are peaking again:

Bear Market Risk Indicator

Our favorite recession model, however, is prepared by iM Market Signals, who has recently been updating its recession charts periodically, as new data points are published and old data points are updated. The latest version of their “Business Cycle Index” is shown below. The “key” is where the heavy “Blue” line crosses the zero-labeled “Red” line – the weeks leading up to the actual recession are also annotated:

IMs Recession Model

As many have said, it is smooth sailing ahead, according to these readings, but data has a way of being revised downward at a later point in time. How much of a cushion exists in the above chart? You only have to look back over the “10” line history to see how quickly the Blue line can dive to zero – 6 to 12 months, if we are lucky, the reason why most analysts really believe that a recession is coming in the 12 to 18 month timeframe.

Concluding Remarks

Economic expansions cannot last forever. They have to end at some point, and, hopefully, we will be prepared for that eventuality, at least better than we were the last time around. Since the banking community is not nearly in the disarray as it was a decade ago, economists are beginning to think that the next recession may not be as severe. The caveat to that conclusion, however, is that the ability of central banks to respond is curtailed, and government deficits are beyond where they need to be.

At the end of the day, Larry Kummer, a portfolio strategist, summed up the present situation by saying: “The US economy has been in a recession roughly 20% of the time since 1854. Depressions were frequent before the creation of the Fed and the use of fiscal stabilizers. Recessions and depressions are less frequent now, but they still happen. Like extreme weather, we have to prepare for the inevitable.”

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.


Popular Brokers