🔋The R Word
Data suggests that the economy is weakening with some indicators nearing Great Depression levels.
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Why an indicator that has foretold almost every recession doesn’t seem to be working anymore. -CNBC
Perhaps famous last words by CNBC, in a sentence that I would’ve replaced anymore with yet. The mainstream consensus is that the economy is robust, inflation is decreasing, and the markets are doing well. With most investment portfolios happy and a presidential candidate assassination attempt not even enough to shake the market, it’s easy to agree with the smooth sails for the economy.
In January 2023 I wrote Year of Pain after Federal Reserve Chair Jerome Powell suggested that the average American would feel some “pain” from their aggressive rate hiking campaign. This is aggressive rhetoric from a government official, but either way, this so-called pain hasn’t manifested yet. At that time, many analysts predicted the US would head into a recession sooner rather than later. I used historical information and correctly suggested in that piece that the recession could be pushed out past 2023.
In January 2024 I wrote Year of Pain… For Real This Time, and updated readers that based on the historical timeline we should see market top and economic troubles at any time now as well as when we actually should expect interest rate cuts from the Federal Reserve. I also reiterated the contrarian psychology that I look for, considering at the time most of the mainstream had flipped into the no recession or soft landing camp.
Eight months later and everything humming along still, it seems unlikely that some event would destabilize the economy or the market to tank before the election. Does this mean the US economy is out of the woods and this resistance is a sign of economic health?
Yield Curve
The recession indicator the CNBC article refers to is the yield curve. The US issues bonds at different durations from 1 month to 30 years. Typically, investors get higher yields for longer-dated bonds to compensate for inflation and uncertainty about the future. When this is reversed or the curve is inverted (the difference between long bond yield and short bond yield is negative), this is a very historically accurate recession signal.
As CNBC and my beginning-of-the-year economy update articles suggest, we are past the time when we historically see the US enter the recession after the yield curve inverts (10y-2y). For some, this implies proof that things are different this time and the US has avoided recession.
There are many yield curves relevant for different parts of the economy, with the 10y - 2y and 10y-3mo being popular. Below is the 10y-3mo curve in blue with a grey line at 0% or the inversion point, recessions indicated by grey zones, and the inversion in yellow zones. Further, the S&P 500 is in black while the market drawdowns post yield curve inversion are in red boxes. You can see the power of this indicator because 7 out of 8 times it has triggered since the 60s it preceded a recession. Even in the times when it did not invert and there was a recession, the spike down in the yield curve gave a warning sign.
One vital piece of information to take away is that the inversion is only a leading indicator. The actual recession indicator is the un-inversion of the curve. Only when the curve shoots back into positive territory do the grey recession zones begin. This is an important consideration for today, as we have not un-inverted yet. I would expect the recession only to occur once that happens. Based on this dataset that I have access to, this is the longest time the US has spent inverted which is why many analysts are confused.
Historically, there is a weak correlation between the number of days inverted and the market drawdown. Some of the worst market drawdowns like 1929 and 2008 occurred after prolonged periods of inversion where stocks were racing higher. The only time the US economy spent more time inverted was 1929 which preceded the great depression and an 89% drop in the stock market. Considering we have been inverted for about 645 days now, that is not great company to be with if you are optimistic about the economy.
Leading Economic Indicators
The conference board, a non-profit organization has a model called the leading economic index (LEI) that tracks the business cycle using financial and non-financial data points independent of the yield curve. It has proved to be a good predictor of recession in its own right. The most recent LEI report suggests that a recession should’ve already occurred as the LEI growth rate is trending higher, but the signal it recorded was a large one. This could be a sign that trouble is behind us, but with such a long lag from the yield curve and the LEI still in negative, it could also turn back lower if the recession plays out. This indicator was not around in 1929, so there is a chance that the long this indicator has not experienced a time like this before.
Employment
The last straw for the economy is employment. When the unemployment rate picks up that is the final nail in the coffin that recession is here. Once people lose their jobs they spend even less money and things like the housing and stock market tend to decrease. At the moment, the unemployment rate remains near record-low levels.
Employment tends to be the last thing to change heading into a recession, well behind the leading indicators I’ve discussed. Looking at the underlying data, the picture is less rosy than the unemployment rate suggests. Full-time employment has been declining and replaced with part-time employment which keeps the overall employment picture the same, even though this isn’t a healthy environment. Typically this occurs heading into a recession. At the same time, the number of people taking on multiple jobs is nearing record-high levels.
Instead of using government statistics, we can also ask consumers themselves what is going on. The current job availability statistics within the consumer confidence survey suggest a declining availability of jobs. Historically, the trend change in this signals recession is soon to follow.
Conclusion
This piece is not meant to doom or scare you, but merely to bring awareness to the risks. Many in the mainstream news or through government channels paint a rosy picture of the economy which is not helpful to prepare consumers for the future objectively. At The Gray Area, we muddle through these challenging places in search of the truth. The length, timing, and severity cannot be known with certainty, but the risks of recession and market downturn are screaming out under the surface for those listening.
With a Shiller P/E ratio (a method of measuring stock market valuation) near 1929 and 1999 bubble levels and numerous signs of recession, I urge my readers to take caution in their lives and portfolios. Once we get there, understanding the government's response will be pivotal in predicting the future. The economy is one of if not the most important topics to consumers and its impact on other topics like energy, electric vehicles, commodities, and policy are intertwined more than people realize. Until next week,
-Grayson
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Well said. Also, as I recall, recessions don't usually begin until the Fed starts cutting rates, oddly enough. Ray Dalio and others have also pointed out that we are at the confluence of three major economic cycle inflection points. Not to mention a Federal deficit that is nearing toxic levels relative to GDP. Could be some crazy times ahead.