moneyFYI
Financial Freedom Is Merely Organized Common Sense
Can There Be A Recession If No One Notices?
The current wisdom is:
- We are in a recession
- A recession will happen in the next nine to 12 months
- No recession is likely
The proponents of each have talking points to support their opinion.
The important thing for we common folk is you can’t tell until it is over. That makes anticipatory management a problem.
Recession with some indicators.
I have oftentimes referred to material produced by Joachim Klement. Yesterday’s newsletter is worth your trouble to read and think about. It offers information about the factors that are highly correlated with a pending recession. You should ask yourself how you would amend your investments if you knew a recession was imminent or already begun.
Should you lighten up the weaker performers in your portfolio so as to have cash to buy bargains as they appear, or wait? It’s not easy, but it is easier if there is something other than a motivated opinion to rely upon.
His comments follow
US recession ahead
This is where a simple analysis by Edward Leamer from UCLA comes in handy. He looked at the development of several key macroeconomic indicators in the three years before the onset of a recession and compared it with the development of these indicators in 2021 and 2022. I will focus on his results based on the data for the first half of 2022, but you can download the full results here.
Leamer looked at the development in US interest rates, inflation, the unemployment rate, and the housing market and estimated the probability that the US will enter recession in the next 12, 24 and 36 months. The table below shows a summary of his findings.
Probability for US recession
In general, the probability that a recession in the US will start in the next 12 months is very high. Inflation data would suggest that it is all but inevitable. Advocates of a soft landing claim that the job market is so strong that a recession is by no means certain and may likely never come. My response to that is and always has been that we learn in Economics 101 that the labour market is a lagging indicator. If you wait for the labour market to show you a recession, you will be 3 to 6 months late. Indeed, Leamer’s analysis suggests that current strong labour market data is perfectly in line with the onset of a recession in the next 12 months. Better not believe the Fed and other economists when they point to employment data as a sign of an economy far away from recession.
Also, housing starts have weakened so much, that we have now roughly a one in three chance of seeing a recession in the next 12 months based on that data alone. But Leamer in his paper also shows that if we look at housing starts not just in the first half of 2022 but in the last 12 months, the probability for the onset of a recession in the next 12 months rises to 77%.
In the end, the only indicator that points to a recession in late 2023 is the steepness of the yield curve which is the most reliable of them all. As I have written here, an inversion of the yield curve is a remarkably good indicator for a recession some 18 months down the road. And the yield curve has inverted in the US since in spring. However, I would argue that this time around, the lead time from the yield curve inversion to a recession is likely shorter than normal, because short-term interest rates were extremely low at the beginning of this year and the Fed needed to hike rates a couple of times before it would move short-term bond yields even close to the 10-year Treasury yield.
To me at least, the data of Edward Leamer confirms my suspicion that the US will enter recession in the next 12 months and possibly already in 2022. Equity markets certainly seem to have that priced in and in my view, they are correct.
You can subscribe to his newsletter here and you should do so.
The bits to take away
The US federal government denies a recession is happening because the labour market is strong. That is a debatable point all by itself since the labour participation rate is so low. As the paper points out though, unemployment is a lagging indicator. That means by the time it is a problem, the recession is well underway.
Anticipating the future is a helpful investment skill. Learn where you can.
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Federal Business Development Bank.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
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