Is a Recession Coming: US Yield Curve Inverted But Check the ISM Report Next Week
Posted on August 30, 2019
I hope you all had a good week! Despite the cheerful greeting, conditions are becoming increasingly challenging amidst the ongoing political and economic malaise. This brings with it new risks and opportunities, depending on how you are positioned. From a portfolio management perspective, longer term investors should be wary of such risks. But shorter term traders may well be rubbing their hands at the potential opportunities presented by a turn in the economy. In this week’s Trading Club video, I used our latest Checklist report to demonstrate exactly where the risks and opportunities lie in global markets, with a particular emphasis on the business cycle.
Whilst I cannot share everything here as a courtesy to our paid members (join them here for full access) I will explain what I believe to be the most important thing that I’m looking at right now.
It begins with our assessment of the business cycle, which has a 'neutral' score of 0 following a sustained deterioration. You’ll see that there is a mix of positive and negative scores amongst the 7 factors represented by the Checklist, hence our total.
On the face of it, you may well think of the neutral score; "so what?”. But when you look at this historical chart of the score, you can see why you should be concerned about it weakening any further from here. Indeed, a negative score has historically signalled a major turning point in the business cycle, and has been our cue to get out of risk assets (such as stocks) ahead of significant declines.
Running through each of the 7 items on our Checklist, the Leading Economic Indicator (LEI) Index has seen negative momentum throughout 2019. Whilst the overall level remains in ‘expansion’ above the baseline, this negative momentum reduces the score to +0.5 for now, and could soon turn negative.
Of most concern is the ‘manufacturing’ component (represented by the ISM Report) which would tip the overall score negative if Tuesday’s release disappoints. With the China PMI (blue line) heading south, it might well drag the US equivalent with it...
It is important to note that (at least until Tuesday’s report) the US ISM remains in expansionary territory. However, it is the negative momentum (Rate of Change, upper panel) that is my cause for concern. The New Orders - Inventories spread (lower panel) still offers some hope as it is slightly positive… but it's certainly a mixed bag here, in a negative trend.
The proxy that we use to gauge the health of the housing market has also turned negative in the past few months...
…though the labour market still looks good.
Consumption is a -1 on our Checklist, given the negative trend in the past year or so.
On the other hand, earnings expectations hold reasonably steady (grey line), with stocks above their long term moving average (red line).
The "elephant in the room” however is the US yield curve, which has recently inverted. The so called ‘desert island’ indicator suggests that we should be preparing for a recession within a next year (give or take 6 months). Certainly not a good omen, and undoubtedly a -1 on our Checklist.
With equities down from recent highs and in something of a holding pattern, it is clear that Central Bank intervention may be needed for them to stage a rally.
Looking at liquidity, the green and red bars show the increase / decrease in the amount of stimulus being provided by the major Central Banks, vis-a-vis global stocks represented by the MSCI World Index overlaid in black (upper panel). The lower panel shows the negative momentum depicted by the 12 month rate of change, which suggests that the banks are yet to respond by giving the support needed to minimise the risk / impact of a recession and market selloff.
Whilst it may have made for heavy reading (especially on a Friday!), you absolutely need to be aware of the big picture that is unfolding. If you would like to join us for our full analysis including new insights each week, or learn from the ground up with online tuition from Lex in our MDT online course, then sign up and take your financial knowledge to the next level right away!
(P.S. Don’t forget to check the ISM Report released 2pm GMT Tuesday!)
James Helliwell | Chief Investment Strategist
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