Tuesday, February 4, 2020

Where Are We on the Recession Front?

Several economic indicators have been disappointing over the last two months: the ISM Manufacturing Index, Durable Goods Orders, Retail Sales, Leading Economic Indicators and Existing Home Sales have all been lower or below expectations in December and early January.

Individually, each of the economic reports noted above would not normally be a sign that a recession is coming soon. Yet collectively, they are worrisome, especially since these are some of the first indicators to weaken ahead of recessions. And this was all happening before the coronavirus became a global concern over the last few weeks.

The Fed repeated its argument last week that “the economy is doing well because consumer spending and the labor market are strong.” And they are right – for now. Real personal consumption is growing at a reasonably healthy 2.4% (annual rate), and the 3.5% unemployment rate is near a 50-year low. Yet the problem is that these are often the LAST segments of the economy to falter historically at the start of a recession.

Put differently, consumers and the labor market should still be strong. The question is, for how much longer? In other words, there is an expected gap of time from when leading indicators such as those listed above show weakness to when coincident indicators (consumer spending and labor) show weakness.

Historically, one of two things happens at or near this point in the economic cycle: Either the leading indicators (manufacturing, durable goods, retail sales, etc.) turn higher once again, and the economic expansion continues; or consumer spending and labor turn lower – and we go into a recession.

This is why what happens with the coronavirus is so critical just ahead, for the US and the world!

Here’s another troubling indicator: The Citigroup U.S. Surprise Index – which measures how far the aggregate of economic reports are above or below where economists estimate them to be – has fallen in recent months.

When the Surprise Index is negative, it means that the majority of economic reports are coming in below expectations, while a positive reading indicates that most data is coming in above expectations. As you can see in the chart, the Index has fallen dramatically since October of last year and has been mostly negative so far this year – thus increasing the odds for a recession.

The discussion above is not intended as a comprehensive analysis of the odds of a recession just ahead, but these are the most common talking points. As I have pointed out often, it is impossible to know when the next recession will arrive, but it may be sooner rather than later if the coronavirus worsens.

In any event, I continue to urge my readers who are largely invested in “buy and hold” strategies and index funds (that will get slammed in a recession) to seriously consider a "buy, hold and sell" strategy, which you can find mentioned several times on this blog. 

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