Recession Red Flags – All 5 Flashing Danger
Is Your Objective to Avoid Recessionary Bear Markets?
Certain investors, those close to retirement, have historically wanted to avoid large capital drawdowns. The Dow Jones Industrial Average has lost an average of -34.9% during a recessionary bear market, with losses ranging from -10.1% to -86.0%, in 2001 the index lost -49.1% and in 2007-2009 it lost -56.8%.
Recession Red Flags
What datapoints could investors follow to determine whether or not they could encounter a recessionary bear market?
Fed Reserve Rate Hikes
The Yield Curve
Leading Economic Index
Real Gross Domestic Income
Broad Stock Market Trend
Federal Reserve Rate Hikes
Some argue that when the Federal Reserve is hiking interest rates too fast and too far that they will cause a recession. Below we can see that there have been 14 instances of the Federal Reserve raising the Federal Funds Rate going back to 1950. We can see that 78% of the time, in 11 of 14 instances, a recession has followed soon after. Notably in the 60s, 80s, and 90s the economy was bursting at the seams with spending on the Vietnam War, the Reagan tax cuts, and the tech boom and the Fed’s trajectory of rate increases was less than todays’ trajectory.
The Yield Curve
In the past 40 years the market has never bottomed when the yield curve is negative.
The yield curve is simply short term rates minus long term rates (the 90 Day T-Bill Rate minus the 10 Year Treasury Rate), it is a data point followed by most money managers. The yield curve is currently -1.49% (as of 08/07/2023). We can see in the graph below (courtesy of stockcharts.com) that since 1980 the market bottoms after the Fed starts cutting the Fed Funds Rate and steepens the yield curve.
Leading Economic Index
When the Conference Board’s Leading Economic Index (LEI) has trended -4% or more a recession has always followed. Presently the LEI is -8%. Chart source The Conference Board.
Real Gross Domestic Income
Looking back to 1945, only 100% of the time, when the year over year percentage change in Real Gross Domestic Income turns negative, the United States has already or will soon enter a recession (chart source Federal Reserve Economic Data and U.S. Bureau of Economic Analysis).
Broad Stock Market Trend
The broad U.S. stock market, as measured by the Value Line Geometric Index (1,600+ U.S. stocks weighted equally) has been putting in a series of lower highs and lower lows going back to January 2022. Many refer to this as a bear trend or a bear market (chart source stockcharts.com).
Conclusion
In my opinion all five indicators are flashing red and investors should consider what impact a recession within a bear market would have on their retirement future.
LPL 467035-1
DEFINITIONS
10 Year Treasury Constant Maturity Minus 90 Day Treasury Constant Maturity - Treasury bond data used in calculating interest rate spreads is obtained directly from the U.S. Treasury Department. Series is calculated as the spread between 10-Year Treasury Constant Maturity (BC_10YEAR) and 90 Day Treasury Constant Maturity (BC_90DAY). Both underlying series are published at the U.S. Treasury Department.
Board of Governors of the Federal Reserve System – The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the monetary policy of the United States. Governors are appointed by the president of the United States and confirmed by the Senate for staggered 14-year terms. It is headquartered in the Eccles Building on Constitution Avenue, N.W. in Washington, D.C..
Conference Board Leading Economic Index - A American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables. These variables have historically turned downward before a recession and upward before an expansion.
Dow Jones Industrial Average - The Dow Jones Industrial Average (DJIA) is an index that tracks 30 largest, publicly owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ. The DJIA is named after Charles Dow, who created it in 1896, and his business partner, Edward Jones.
Federal Funds Rate - Set by the Federal Open Market Committee (FOMC), this is the rate at which commercial banks borrow and lend their excess reserves to each other overnight. The FOMC, which is the policymaking body of the Federal Reserve System, meets eight times a year to set the target federal funds rate, which is part of its monetary policy. The level of the rate can be used to help increase or slow economic growth.
Federal Reserve Economic Data (FRED) – a database maintained by the Research division of the Federal Reserve Bank of St. Louis that has more than 500,000 economic time series from 87 sources. The data can be viewed in graphical and text form or downloaded for import to a database or spreadsheet and viewed on mobile devices. They cover banking, business/fiscal, consumer price indexes, employment and population, exchange rates, gross domestic product, interest rates, monetary aggregates, producer price indexes, reserves and monetary base, U.S. trade and international transactions, and U.S. financial data. The time series are compiled by the Federal Reserve and many are collected from government agencies such as the U.S. Census and the Bureau of Labor Statistics.
Real Domestic Income - is a measure of a nation's economic activity that is based on all of the money earned for all of the goods and services produced in the nation during a specific period.
U.S. Bureau of Economic Analysis - is a U.S. government agency that provides official macroeconomic and industry statistics, most notably reports about the gross domestic product (GDP) of the United States and its various units—states, cities/towns/townships/villages/counties, and metropolitan areas. They also provide information about personal income, corporate profits, and government spending in their National Income and Product Accounts (NIPAs).
Value Line Geometric Index - The Value Line Composite Index is a stock index containing approximately 1,675 companies from the NYSE, American Stock Exchange, Nasdaq, Toronto, and over-the-counter markets. The Value Line Composite Index has two forms: The Value Line Geometric Composite Index (the original equally weighted index) and the Value Line Arithmetic Composite Index (an index which mirrors changes if a portfolio held equal amounts of stock.)
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