With volatile equity markets, falling corporate earnings growth, and the Federal Reserve slowing its rate hike path—but not as quickly as some had hoped—many investors fear that the New Year could usher in a recession.
We don’t see it that way.
Focusing on some key areas, and using history as our guide, here are six reasons why a U.S. recession is not in our 2019 forecast:
The flattening yield curve doesn’t indicate a recession: The gap between yields for 10-year bond and two-year Treasuries is diminishing (a mere 20 basis points, recently), but the flattening yield curve does not yet point toward recession. Since late 1976, there have been seven times when the yield curve was flat or inverted, with an average duration of 10 months. Five of those seven periods were followed by recession, with the downturn coming as soon as nine months later, as long as 22 months later. Twice, inverted yield curves did not result in recession, possibly because the inversions were shorter than three months in duration.
An inversion is a concern, certainly, since lending and risk-taking generally decline during such periods. But it’s too early to conclude that what we’re seeing now points to recession any time soon.
Considering historical patterns, we’d need to see an inversion period lasting longer than three months, and even then, recession would follow (on average) 17 months later.
The new-housing market is not on the ropes: New-home sales have taken a beating in 2018, falling 12% compared to the same period a year earlier. The decline began in the Spring, when the 10-year Treasury yield hit 3%. We believe increased rates have caused short-term sticker shock and expect the resulting decline in new home prices will lure buyers back in. In the just released data, new home building permits and new home construction came in higher than expected. While higher rates have put a new-home purchase out of reach for more people, real income is growing at a clip of more than 2%, and new home prices are coming down slightly (about 3% compared to a year ago). With housing affordability still elevated relative to historical trends, we expect demand to resume as prices continue to decline.
Global oil demand is strong: There’s nothing quite like a 30% drop in oil prices since September to suggest a slowdown in the economy. The fact remains, however, that global oil demand is up 1.3% year over year. (The average over the past five years has been 1.5% YoY.) Therefore we believe that while the global economy has lost some steam, the price drop is due more to an excess supply of crude (something OPEC recently addressed by announcing a cut in production.)
High-yield spreads are, on the whole, well within long-term norms: Recently, the gap between yields for high-yield bonds and investment-grade/Treasury debt has spiked. That has many worried for emerging markets and economically-sensitive segments. However, almost all industry segments have high-yield spreads well within 20-year norms. The exceptions are retail (which has been the case since 2015) and, recently, the energy sector, which has been under pressure from decreasing oil prices, resulting in widening credit spreads.
Earnings estimates are falling, but mainly in isolation: Since September, consensus forward earnings estimates are down 2%. U.S./China trade tensions are part of the reason. But most of the damage can be isolated to the energy and basic-materials segments, which got hit by falling commodity prices.
Leading Economic Indicators are strong: The U.S. Leading Economic Index (which weighs unemployment, building permits, stock prices, consumer sentiment and other factors) most recently came in at plus 5.9%, year over year. That’s less robust than its recent four-year high of 7%, but consider this: Since the mid-1960s, it’s taken an average of 21 months for the LEI to fall into negative YoY-territory from its peak. Using that as a guide, and with actual Gross Domestic Product trailing LEI by six months, that points to a recession more than two years from now.
The LEI’s fastest descent below zero YoY from its peak level was 10 months (in 2001). So if that’s the worst-case scenario, that would indicate a recession not before Spring 2020. About a third of the time, LEI falling below zero YoY has not resulted in recession six months later.
We understand investors’ jitters but we don’t believe a recession will hit any time in 2019.
Paul Buongiorno is a Managing Director of Tiedemann Advisors LLC. Tiedemann Advisors is an investment advisor. The information presented herein is intended as an illustration of the services offered by Tiedemann and such services may not be suitable for all individuals. This information does not constitute, and should not be construed as, the provision of tax, accounting or legal advice or investment recommendations. This information is intended to serve as the basis of a discussion with a Tiedemann professional. We urge you to consult with your tax or legal advisors prior to entering into any planning or trust arrangements.
Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Investors should seek advice from their investment professional to review their specific information. Asset allocation does not guarantee a profit or protection from losses in a declining market. Investments in securities involves significant risk and has the potential for partial or complete loss of funds invested. Investments, when sold, may be worth more or less than the original purchase price. The CONFERENCE BOARD’S LEADING ECONOMIC INDEX (LEI) is one prominent economic indicator. It is designed to predict future movements in the economy based on a composite of 10 economic indicators (for example, manufacturers’ new orders, stock prices, and weekly unemployment claims) whose changes tend to precede shifts in the overall economy. The U.S. REAL GROSS DOMESTIC PRODUCT (GDP) is an inflation-adjusted measure that reflects the value of all goods and services produced by the U.S. economy in a given year, expressed in base-year price.