Why we feel recession talk is premature

Matthew F. Beaudry

Matthew F. Beaudry
Senior Investment Director, 04/12/18

  • Rising market volatility and headlines about trade war are prompting questions about a recession.
  • Awareness of recession risk is important for asset allocation decisions.
  • Two key recession indicators signal little risk for the coming year.

Is an economic recession on the horizon? Not if history is any indication.

In our Market Perspectives data analysis, we favor two key signals that have historically been highly consistent in heralding the onset of a recession in a time frame that may be helpful for investors making long-term portfolio decisions. These two indicators are the year-over-year change in the Leading Economic Index (LEI) and the difference between the yields for the 2-year and 10-year Treasury notes. Currently, neither of these signals is warning of a recession on the horizon.

The Treasury yield curve has inverted in front of every recession since 1956 for 10 out of 10 times. (The yield curve inverts when the market places a higher value on long-term securities than on short-term securities, a sign that investors are more worried about near-term economic growth than they are about long-term inflation. When the curve inverts, the difference between 2- and 10-year yields becomes negative.) Over the past several months, while the yield curve has flattened, it has not inverted.

Leading Economic Indicators are exactly what they claim to be, a set of signals that provide a view of future economic activity (tracked by the Conference Board). When the change in the LEI is negative, a recession has historically followed six to 12 months later. Today, the LEI year-over-year change is positive and accelerating.

The yield curve and Leading Economic Indicators do not show pre-recession trends

The yield curve and the year-over-year LEI are not the only leading indicators used to monitor economic recession risk. Economists also track the overall level of the LEI in addition to its year-over-year change. When the overall level of the LEI hits a new high by rising above its peak in the previous economic cycle, the next recession has historically been over four years away. The LEI made a new high 12 months ago.

The LEI reached new levels only a year ago

Economists also track jobless claims as a recession warning. New claims have historically spiked dramatically ahead of a recession. Currently, jobless claims are at 40-year lows.

New jobless claims are trending down, not up

The key point to remember is that, historically, economic recessions lead to bear markets. That’s why it is so important to monitor the potential for recession when making asset allocation decisions.

Today, indicators with high historical efficacy of forecasting economic recessions are signaling little to no chance of an economic recession over the next six to 12 months.

You can find updates on recession and other economic indicators each quarter in our Market Perspectives presentation (login required).