People are starting to worry about a recession. Based on the Federal Reserve’s reaction, it is too. Yet, recessions don’t just happen without warning and economic expansions don’t come with set expiration dates.
Still, recessions are natural. We tend to travel between emotional peaks of euphoria to depression and back again. But, along the way, the pace of economic activity experiences fits and starts, and the data sends mixed or false signals. This adds to a sense of futility in trying to forecast economic turning points.
When recessions do occur, however, they have a big impact. Our last two recessions produced stock market losses between 50 and 60 percent. In comparison, the average decline during a recession has been more than 30 percent. Whether severe or pedestrian, it highlights the importance of being both financially and emotionally prepared heading into a recession.
On the employment front, two leading indicators look sound, regardless of the weak jobs report for May. Initial claims for unemployment benefits are still very low and aren’t really moving demonstrably higher. The same steadiness can be seen in the average weekly hours worked by employees in manufacturing. Remember, these are jobs-related data points that tend to show weakness before the onset of a recession.
Next, the latest readings of an index that tracks the mood of the manufacturing sector are down from a year ago, but still don’t point to a recession. Another leading indicator, new orders for durable goods, have also barely seen a downtick. Finally, a measure of the delivery speed of suppliers has weakened slightly, but also doesn’t reach recessionary-level readings.
Turning to the housing industry, the number of building permits for new homes has basically been flat for the last couple of years and is only down a bit from last spring. Incidentally, the current number of building permits now sits at a little more than half the level seen before the financial crisis. So, the housing industry may not have quite the economic impact as it once did. In addition, mortgage rates have recently dropped, probably providing a backstop.
Consumer confidence readings also are still quite high. After the stock market downturn late last year, confidence did fall off some. However, up until the last couple of weeks, we’ve seen a rebound in consumer confidence surveys. It should be said that the tight correlation between consumer confidence surveys and the most recent performance of the stock market tends to make this a chicken-or-egg type of indicator.
With the fundamental economic indicators largely in the clear, what remains are the financial market-based indicators. Since these show up on your brokerage statements, they do tend to garner attention, especially in the media.
The most worrisome is the now-inverted yield curve. This just means that longer-term interest rates are lower than short-term interest rates for government debt. While it is not a fool-proof signal, when a yield curve inversion occurs, the odds of an oncoming recession rise. But, remember, it has successfully predicted nine of the last five recessions! (Editor's note: That's an old financial joke that means it can send false signals.)
The Fed has certainly snapped to attention. It is now strongly signaling interest rate cuts, rather than hikes. Its about-face has been very sudden and this perhaps adds to general nervousness. To quell the impression of panic, the Fed is framing its reversal as simply taking out an “insurance policy” on the economic expansion. Of course, their justification for doing so goes well beyond the shape of the yield curve in the age of Trump tweets that threaten our relationships with our major trading partners.
As I mentioned in my most recent column, the uncertainty created by the threat of trade wars does matter. It is worthy of making some proactive, risk-management portfolio adjustments. Yet, as I read the key economic data that historically behave as leading indicators of an oncoming recession, I don’t currently see obvious red flags flying. My advice is likely as bland as it is wise; keep an eye on the hard data, know your portfolio risks, develop a reaction plan and, most of all, guard against making emotional moves.
Jason P. Tank, CFA is both the owner of Front Street Wealth Management, a purely fee-only advisory firm and the founder of the Money Series, a program committed to providing open-access to financial education, for all. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com.