Guggenheim’s Model Points to Recession in Late 2019 or 2020

Report Highlights

· It is critical for investors to have a well-informed view on the timing of the business cycle because of its importance as a driver of investment performance.

· Our Recession Dashboard includes six leading indicators that exhibit consistent cyclical behavior ahead of a recession—and can be tracked in real time.

· Based on the dashboard and our proprietary Recession Probability Model, which shows 24-, 12-, and six-month ahead recession probabilities, we believe the next recession will begin in late 2019 to mid-2020.

· Risk assets tend to perform well two years out from a recession, but investors should become increasingly defensive in the final year of an expansion.

Introduction

The business cycle is one of the most important drivers of investment performance. As the nearby chart shows, recessions lead to outsized moves across asset markets. It is therefore critical for investors to have a well-informed view on the business cycle so portfolio allocations can be adjusted accordingly. At this stage, with the current U.S. expansion showing signs of aging, our focus is on projecting the timing of the next downturn.

Predicting recessions well in advance is notoriously difficult. Using history as a guide, however, we find that it may be possible to get an early read on when the next recession will begin by analyzing the late-cycle behavior of several key economic and market indicators. Together, they would have provided advance warnings of a downturn. Our analysis of these metrics suggests that the current expansion will end as soon as late 2019.

Identifying Common Late-Cycle Symptoms

Economists, including those at the Federal Reserve (Fed), are fond of saying that business cycles do not die of old age. Rather, they tend to point to policy mistakes, bursting asset bubbles, or other shocks as recession catalysts. We think this conventional wisdom misses an essential point, which is that as a business cycle ages it becomes increasingly vulnerable to these life-threatening conditions. Indeed, history shows that economic cycles exhibit fairly consistent symptoms leading up to a recession, starting with a labor market that evolves from cool to hot and a monetary policy stance that progresses from loose to tight in response. That is not to say the Fed deliberately causes recessions. Rather, an overheating labor market makes the Fed nervous about the inflation outlook, resulting in a degree of policy tightening that flattens the yield curve and begins to slow the economy. Softening growth in demand results in a decline in the pace of net job creation and a pullback in business investment and consumer spending. Credit conditions tighten and asset valuations drop, typically from cycle highs. This combination of events is often sufficient to tip an overextended economy into recession.

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