‘Recession Dashboard’ Update: US Remains Resilient

But what about the yield curve inversion¹ discussed in previous versions of our Recession Dashboard? Any competent economic forecaster must be intellectually honest about the efficacy of their tools — and anyone solely using yield curves to try and predict the timing of a US recession since 2022 would have been sorely disappointed. The Fed’s unprecedented monetary policy intervention since the financial crisis in 2008 may have decreased the efficacy of this indicator during the current cycle.

Labor Market Signals: Mixed – Valid Concerns… But Not Uniformly Negative

Slowing employment trends can give important warning signals concerning the health of the economy. The weaker than expected payrolls report and the move up to 4.3% in the July unemployment rate caught investors’ attention. However, we would note that more than half of the unemployment increase was related to ‘temporary layoffs’ — a category possibly affected by inclement weather, and one that does not tend to strongly correlate to recession risk, in our view. Helping corroborate this point, other employment-related indicators such as our non-farm payroll tracker — while clearly slowing from 2023’s torrid pace — remains above 1%, a level we view as being consistent with suggesting imminent recession (red dotted line, Chart 2, below).

Consumer-Related Signals: Mixed – Confidence Weak, but Spending Solid

Monitoring the consumer is important, given that consumer spending represents nearly 70% of the US economy. Here the news is mixed. A large drop in the difference between the Conference Board’s Consumer Expectations Index and its Present Situation Index has historically presaged recession, but the lag times vary greatly. This indicator has been in negative territory consistently since inflation flared in the wake of the pandemic. However, in addition to the level of this indicator, we think direction also matters. From a directional perspective, this indicator has been generally trending up (i.e., less negative) since February of last year, as inflation started to trend down. This seems more congruent with strong recent retail sales and personal consumption expenditures (PCE) data, as well as positive earnings and commentary from the largest retailer in the US by volume. Putting the mosaic together, we would currently categorize the US consumer as wary but resilient…particularly among higher earners.

Construction Spending: Positive – More Measured but Growing

Construction plays an important role as a job creator across many industries and as a driver of demand for both natural resources and finished goods. Construction spending grew around +6% as of June, the most recent data release. We track this closely, as construction spending historically has a high correlation to US GDP. Another related data point is yearly heavy truck sales[1], which are running around 40k units/month…suggesting reasonably strong demand for goods and construction.

Leading Economic Indicators (LEI): Positive – LEI Continues to Improve

The Conference Board’s ‘Leading Economic Indicators’ (LEI)² is a predictive variable that is designed to anticipate turning points in the business cycle by roughly 7 months. The LEI has now risen consistently since the spring and has now moved above the level which we typically associate with pre-recessionary conditions (red line, Chart 3, at right). Other indicators of economic activity we track tell a similarly constructive story; US composite Purchase Managers Index (PMI) readings are still in expansionary territory, and US industrial production recently hit a cycle high. Lastly, we would note that potentially one of the best leading indicators of the economy — the stock market itself — remains only a few percentage points off its’ all-time high made in July…even after the recent bout of volatility.

CONCLUSION:

 

Weight of Evidence Does Not Suggest Imminent Recession

The weight of the evidence in our dashboard points to a slowing US economy in the back half of the year in our view, but not a recession. This is commensurate with a US economy that, according to the Atlanta Fed’s GDPNow tracker, is growing at close to a 2.5% clip for Q3, a little slower than last quarter. While we do not expect as many rate cuts as the market is pricing in, we do expect the Fed to cut in ’24 — a stance underlined by benign recent inflation data such as last week’s lower-than-expected producer price inflation (PPI) and in line consumer inflation (CPI) readings.

While stock volatility is likely to remain elevated into the US election, we believe an growing economy combined with a likelihood of Fed rate cuts should continue to be constructive backdrop for equity investors. We remain overweight stocks, with an emphasis on the US, across our balanced portfolios. However, in keeping with our investment mantra of ‘Process Over Prediction,’ we recognize data can change quickly and we will remain vigilant in monitoring macro risks.

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¹ An inverted ‘yield curve’ – the difference in yield between long-term and short-term interest rates – has historically been a signal of impending recession, as falling long-term interest rates often mean bond investors expect some combination of lower future inflation and growth. When they fall below the levels set by the Federal Reserve, the bond market is suggesting the Fed has raised rates too much.

² Heavy trucks weigh over 26,000 pounds and include 18-wheeler tractors, cement mixers and city buses.

³ The LEI is comprised of ten indicators related to employment, business orders, residential housing demand, stock market prices and bond market credit conditions.

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Index Definitions:

Standard & Poor’s (S&P) 500 Index measures the performance of 500 large cap stocks, which together represent about 80% of the total US equities market.

Definitions:

The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price.

The Composite Index of Leading Indicators, otherwise known as the Leading Economic Index (LEI), is an index published monthly by the Conference Board. It is used to predict the direction of global economic movements in future months. The Index is composed of 10 economic components whose changes tend to precede changes in the overall economy. Businesses and investors can use the index to help plan their activities around the expected performance of the economy and protect themselves from economic downturns.

The Expectations Index is a component of the Consumer Confidence Index® (CCI), which is published each month by the Conference Board. The CCI reflects consumers’ short-term—that is, six-month—outlook for, and sentiment about, the performance of the overall economy as it effects them. The Expectations Index is made up of the average of the CCI components that deal with six-month outlooks for business, employment, and income.

The Present Situation Index is a subindex that measures overall consumer sentiment regarding the present economic situation. This index is determined via a survey conducted for the Conference Board by Nielsen, and it is used to derive the Consumer Confidence Index. This is also sometimes known as the Current Situation Index.

Personal consumption expenditures (PCE), also known as consumer spending, is a measure of the spending on goods and services by people of the United States. According to the Bureau of Economic Analysis (BEA), a U.S. government agency, PCE accounts for about two-thirds of domestic spending and is a significant driver of gross domestic product (GDP).

Real gross domestic product (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year. Real GDP is expressed in base-year prices. It is often referred to as constant-price GDP, inflation-corrected GDP, or constant-dollar GDP. Put simply, real GDP measures the total economic output of a country and is adjusted for changes in price.

The Purchasing Managers’ Index (PMI) is an indicator of the prevailing direction of economic trends in the manufacturing and service sectors. The indicator is compiled and released monthly by the Institute for Supply Management (ISM), a nonprofit supply management organization.

A yield curve is a line that plots yields, or interest rates, of bonds that have equal credit quality but differing maturity dates. The slope of the yield curve can predict future interest rate changes and economic activity. There are three main yield curve shapes: normal upward-sloping curve, inverted downward-sloping curve, and flat.

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