A Slowdown is in the Bag, but What About a Recession?
There is little doubt that the US economy is in a state of slowdown. That’s actually a good thing, because it offers some time to pause and refresh, thereby postponing either a recession, overheating or both. These pauses perform the same function as a pit stop in a car race, where a quick refueling and servicing reduces the possibility of burst tires or even engine failure when the car returns to the race. The big question, is “How will the economy emerge from this slowdown?” Will it be with renewed growth like 2016? or Does it fall into a full-blown recession a la 2007? The answer to that question is unknowable at this point in the cycle. What we can do though, is to examine a few indicators that we have successfully used as investment managers for guidance in the past.
For stock market investors, the difference between slowdown and recession is a very important consideration in protecting portfolios from major drawdowns. That’s, because slowdowns are usually linked with mini-bear markets of 10-20%, and in some instances no decline at all. On the other hand, recessions are associated with some of the most severe bear markets on record. The distinction is also important, because slowdown associated bears usually develop under the context of a secular bull market. For instance, there were two slowdowns in both the 1960’s and 1990’s. Each of those periods experienced a secular bull market. Since the last business cycle contraction, in 2008-9, the economy has experienced two slowdowns. One took place in the 2011-12 period, and another between 2015 and 2016. Both experienced mini-bear markets, which formed part of a secular equity uptrend. There are no instances where recessions have been separated by three growth slowdowns. We will soon find out if the current situation breaks from the past. Certainly this business cycle expansion has been unique in many ways, including the fact that it has been amongst the longest, yet slowest on record. How and when it ends could also be unique.
The Reality of a Slowdown
Chart 1, features the Chemical Activity Barometer (CAB), a composite leading economic indicator, published by the American Chemistry Council. The red highlights indicate NBER defined recessions and the beige ones, slowdowns. These are defined as a period when the smooth momentum declines but reverses to the upside prior to a negative equilibrium crossover.
The vertical lines show a 41-month cycle, which seems to explain many of the momentum troughs and several of the cyclic peaks. That’s not surprising since the average time between recessionary troughs in the 1857-1960 period was 41-months. Since then, the economy has experienced seven recessions, and by our count, eight slowdowns. That’s an average trough to trough separation of 40.7 months. Chart 1, which centers the 41-month cycle at the 2009, correctly called for the 2012 and 2016 lows. The next one is projected for the late summer of 2019. A better approach though, is to appraise the status of the indicators at that time, rather than simply relying on a simple average of prior cycles.