Tuesday, August 20, 2019

Are We on Recession Watch?

While the yield inversion was only short lived last week and while yields are ridiculously low, where are we now? There just isn't anything that might bring on a panic-attack. 

Kelly Evans at CNBC, in her noon newsletter today, provided a very astute explanation of what to watch for. Hint: The easy-to-forget credit markets are important! 

You can sign up for her newsletter, called The Exchange, here. I recommend you do. 

Here's a copy of today's newsletter.

With everyone now on recession watch, let's talk about a couple of things to be watching for. A kind of "field guide" to the yield-curve-pocalypse.

There are two main avenues to watch: the real economy, and the financial markets. And you have to watch them both if you want to avoid "false positives." As the old Paul Samuelson line goes, the stock market has predicted nine of the past five recessions. And the economists always just say "there's a 40% chance" of a downturn.

The best leading indicators of the real economy are probably jobless claims and the ISM manufacturing survey. But you have to make sure they're both deteriorating in an obvious and sustained way. Jobless claims are in great shape these days. The ISM survey is not, but you've heard my arguments for why it might need to be taken with a grain of salt right now.

Now, as for financial markets. We all watch the obvious stuff: the stock market, bond yields, the yield curve, etc. But credit markets do not get the attention they deserve because they are the key tell as to whether credit provided by the financial markets to the real economy is crunching up a la 2007 or not.

What do I mean by credit markets? Watch what companies are doing. This is the kind of seemingly boring two-paragraph stuff buried in the back of the Wall Street Journal. In fact I can't even find this Bloomberg write-up of 3M's debt deal online to link to.
But it's a great example: 3M yesterday sold $3.25 billion of debt at a spread of 1.3 percentage-points over comparable Treasuries, "down from initial price talk of around 1.45 percentage-points," per the article. This was to fund "their biggest acquisition ever," of a medical products maker called Acelity. I know, zzzzzzz.
It's not boring, though! Remember how 3M just had an awful earnings report back in April and the stock had its worst day since 1987? But now, with markets "panicking" about the yield curve inversion and a recession, demand for 3M's debt is so strong that the company barely has to pay more than the rock-bottom yields on "risk-free" U.S. Treasuries!
This is the kind of stuff to watch. It tells you there is no credit crunch--the harbinger of recession--in sight. In fact, credit markets are supposed to be basically closed right now for the last sleepy days of August. Instead, there was a higher-than-normal amount of corporate debt priced yesterday alone (aside from 3M, there was also Juniper, Puget Sound, Boston Properties, to name a few).

It's a little trickier to follow, but well worth it for the next few months...and years. Other bull market signs: debt-financed corporate takeovers, debt-funded mergers, and so forth. (Where is demand for all this debt coming from? Pension funds, for one, but more on that later.) Of course that doesn't mean it will all end well, but it means "the music is still playing"--yield curve inversion or no.

Schwab has a more in-depth outlook in their recent analysis:
Schwab Market Perspective: Mixed Picture Getting More Concerning

Key points on the above article: 

  • With cracks forming in equity markets and economic uncertainty mounting, we believe it could remain a bumpy ride over the next few months. 
  • U.S. economic data is mixed but there are signs that manufacturing weakness is bleeding into the service side of the economy; although the consumer remains a support. Pressure is building on the Fed to be more aggressive in cutting rates, but we have doubts additional cuts will be the elixir for what ails the U.S. or global economy. 
  • A global manufacturing recession appears to be underway; if not yet an overall global economic recession.

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