Saturday, October 5, 2019

The recession is coming....

Now that I am in a semi retirement mode, I have more time to read and watch the news. Almost every other day, I read about the recession like a gathering storm. The news reporters/financial analysts show an economic indicator, and then talk about the market crashing. Obviously, this is an attempt to get more viewers and hits. Of course, I like to double check their facts.

Inverted Yield Curve

This indicator is simply based on the 2Yr Yield - 10 Yr Yield. Over the last few recession, it has predicted the upcoming recession. Note that there was a false alarm in 1998.
This indicator has been blasted in the news channel recently especially with a recent inversion a month ago.

If you look at the graph above, the previous recessions had inversions which lasted for several months before the actual recession.

Therefore, I don’t think we are quite there yet.

Purchasing Managers' Index (PMI)

The ISM PMI dragged down the market by 800 points this week.

The PMI is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories. A PMI index greater than 50 indicates expansion  Less than 50 shows a contraction.
The reason why the market is jittery is because it is currently at 47.8  the previous month was around 49.  So we had a couple of months of contractions  

After grabbing the PMI data since 1948, and correlating with the recession months, you can clearly see that a PMI indicator around 42 means that we are in a recession.
The trend is definitely going downwards. If we get to 45 then I think we have a high probability of a recession in the coming months. 

Salm's Unemployment Rate

The unemployment is at its 50yr low. This must be good news right? The market thought so, and were up by 3%.
Unfortunately, the absolute number is not a good indicator. A better way is to use the average of the last 3 months' rate compared with the lowest rate from the trailing 12 months. This method, proposed by Sahm is tightly correlated with  the recessions since 1948.

Note that this is a lagging indicator meaning that it’s difficult to predict a recession. This means it’s tough to hedge your bets and start protecting your assets.
With the current unemployment rate at its low, a 10% increase means the actual unemployment rate is only at around 4% Thus is still low, but if you trust the indicator, it means a recession Is just aroun the corner. A 5% unemployment rate in the next few months means the recession is already here.

For now, I am looking at closely at how quickly the unemployment rate will increase. If the rate is nice and slow, then we’re in a good shape. If the rate of increase is rapid, then this is bad news. 

Leading Economic Indicator (LEI) and Coincident Economic Index (CEI)

The Leading Economics Indicator 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. On the other hand, the Coincident Economic Index (CEI) is a measure of current economic activity.

As you can see below, both indicators are tightly correlated with the recession especially when the indicators are below 0. 

My thresholds are 0.5 for the LEI and 0.2 for the CEI. If the downward trends of these indicators go below the thresholds, then the recession is near. For now, the trends are relatively flat which means we’re still okay. 

Of course a recession is coming. But I don’t think we are there yet. The indicators are definitely currently showing a downward trend. If the PMI indicator dips below 45 or the Sahm indicator gets higher than 0.1 then I will start to get worried. The LEI and CEI are also not showing a drop. Lastly, the yield curve is not deep enough in the negative. Currently, it is positive.

Now, if a recession is coming, what should we do? This obviously depends on your situation. Maybe a future post?

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