If one were prone to worry, there are lots of things to be uneasy about. Ongoing tensions in the international political situation might be a good place to start, with trade disputes front and center. It appears that the markets have spent the last few weeks digesting the likelihood of continued trade disruptions. Reasonable people likely have their own list of other concerns. One we seem to keep hearing about is whether a recession is imminent.
Business cycles wax and wane; that’s been the general story. Since the ‘08 financial crisis, we have experienced a lengthy, but never frothy, recovery. Most market wags anticipate that, at some point, the economy would be expected to turn lower, if only because that has been what history shows. Given that it has been about ten years since the last downturn, it’s almost logical to hear warnings of recession ahead. However, past Fed chair Janet Yellen once said that economic expansions don’t die of old age. It's reasonable to ask, “What would be the trigger?” and “Can I know in time?”
Preceding the last several recessions, there were some recurring mileposts which may serve as warning flags for the arrival of the next recession. These included a pickup in unemployment claims, an inverted yield curve, average hourly earnings growing by an annual rate of roughly about 4%, a surge in commodity prices, and a Federal reserve that had been hiking rates for between 3-7 years. Let’s examine these data sets and see if they’re giving us any signals we should be concerned about.
Maybe first on the list would be employment. Recent job gains appear to be substantial and the unemployment rate has moved lower. The April 2019 unemployment rate was 3.6%. This is the lowest rate of unemployment in about 50 years.
Weekly unemployment claims also show a healthy economy. When an economy is weakening, evidence often shows up in unemployment claims. But claims remain near historic lows. Nothing to see here, folks.
Next on our list is the Treasury yield curve. Here the reader can make his or her own “call”; the three-month Treasury bill and the ten-year Treasury note are in the same yield neighborhood. Inverted, no, but worth watching.
The next milepost to watch is average hourly earnings. In the chart below, the annual growth in average hourly earnings has been increasing in recent years but remains below 3.5%. So again, it bears watching but nothing to be too concerned with here.
Next on our list is a surge in commodity prices. One of the best barometers to check here is the Commodity Research Bureau (CRB) raw industrials spot price index. We are looking for a surge, or meaningful move upward. While it could be said that there was a surge in 2015 following the decline of 2014-15, it seems pretty clear that nothing in the 2018-19 timeframe in the chart below could be called a surge.
Lastly, the Federal Reserve and rate hikes. We can see in the chart below that the Fed embarked upon its current rate hiking cycle in late 2015 and after waiting a year, conducted a number of subsequent hikes in the Fed Funds Rate. For now the Fed appears to be on pause, reversing course in January after making comments late last year implying there were more rate hikes to come. Nonetheless, this data set tells us that the Fed has indeed been hiking for several years now. So with respect to this particular milestone, we can check the box.
So to recap, of the five milestones we reviewed which are likely to help provide a heads’ up of the next recession, whenever it may arrive, we have one check mark (Fed rate hikes), two to keep an eye on (inverted yield curve and average hourly earnings), and two which are showing no signs for concern (weekly unemployment claims and commodity prices). What this tells us is that if our current cycle is typical, we shouldn’t be concerned about an imminent recession at the present time.
The trade war with China is still a developing story, and it’s possible that future developments which we cannot predict may negatively impact our economy and help bring on a recession. But it’s also possible, if not probable, that well before such a scenario came to fruition, a deal will be reached between the two sides that could reduce or eliminate the negative impact to our economy. Such a deal would go a long way to improving confidence among businesses globally which are trying to navigate the choppy waters created by the wake of the trade war between the U.S. and China.
Given that this economic cycle is different in some ways from the last cycle, even though it may rhyme, what brings on the next recession might well be something completely different than what brought on the end of the last cycle (implosion of massive housing bubble, Fed rate hikes, financial crisis).
At Roosevelt, part of our investment process includes monitoring the economic data and discussing its implications on the portfolio and on the cycle. We’ll continue to be vigilant on this front since our cycle is indeed long in the tooth, but for now we do not believe a recession is likely in the next 12 months.
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