Is a recession coming? Is Christmas coming?
Both questions have the same answer. Yes. Recessions will continue to happen as long as economic data is tracked with some degree of certainty and Christmas will continue to come every December. With that being said, the better question to ask could be “How long until the next recession?” or “What can help us identify a looming recession?”
The Price Group utilizes 12 indicators that help us prepare for a recessionary type of environment.
No one indicator has a 100% batting average – that is why we use 12. Saying there is a recession coming when only looking at one indicator (i.e. an inverted yield curve) is like saying “I take a multi-vitamin in the morning so I am healthy”. Taking a multi-vitamin might be one piece of a healthy lifestyle but it cannot define the status of your health.
Illustrated below is how these economic indicators have helped us identify recessions in the past:
Is our process perfect? No. With that being said, history tends to rhyme.
What is a yield curve inversion?
We have received many questions from clients this month about an inverted yield curve. What is it? Why is it significant? In a healthy bond market, long-term interest rates (20 – 30 year bonds) yield more than short term interest rates (2 year bond). This makes sense. If you are going to invest your money for a longer period of time, you typically desire a higher interest rate. A yield curve inversion is when short term interest rates yield more than long term interest rates.
Many claim an inverted yield curve causes a recession. For the record, an inverted yield curve does not cause a recession. Typically, the yield curve inverts because the Federal Reserve drives short term interest rates too high. It is the over-tightening monetary policy that causes the recession. The inverted yield curve is only a symptom of the real issue.
As recently as October 3, the Fed chairman said that U.S. interest rates were “a long way from neutral”. Neutral meaning the level at which interest rates will not increase nor decrease economic growth. Just a few weeks later, the Fed chairman described interest rates as “just below neutral”. Does this mean that the Fed is projecting fewer interest rates hikes over the next 12 months?
Currently, the yield curve is very flat. There is not a lot of difference between short term interest rates and long term interest rates. With that being said, longer bonds are still yielding more than shorter bonds (read: normal). If the yield curve does invert (10 year bonds yield more than 2 year bonds), should we be worried? Not immediately. Historically, there has been an average 2 year lag time from when the yield curve inverts and when a recession starts. As you can see below, the average performance of the market in the year following the initial yield curve inversion is quite high at 22%.
Conclusion
We still think it is premature to make a call about a future recession given our indicators. Fundamentals still look good. Higher interest rates almost always slow economic activity – housing and automobiles being two of the main affected industry’s. But how much will higher interest rates slow down consumer spending? This is the question that is very hard to answer. We think that tariff disputes are only a “front” for the dispute between American and China. The real battle is revolving around technology and company trade secrets. As of today, we do not see a recession in the coming months but feel that higher interest rates will be a headwind for the economy.
Any opinions are those of Randy Price and Matt Price and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.