Other than permanently bearish writers and investors, few address the possibility of the U.S. falling into a recession. Many conclude that the Federal Reserve’s ultra-low rate policy completely altered the landscape such that the idea of a business cycle no longer exists. Others merely ignore warning signs until, unfortunately for them, the opportunity to reduce investment risk has passed them by.
Until recently, I have only discussed the possibility of a recession in the context of a Fed policy mistake. (Thank you, Captain Obvious.) Indeed, I have addressed the pervasive concern that the central bank might raise rates too quickly and/or too frequently, hampering U.S. economic growth that has relied upon stimulus for six-plus years.
However, a social media participant reminded me of an article that I wrote back in December 2007. In my feature, I shared my personal predictive model for determining the probability of economic contraction. In December 2007, my model placed the recession likelihood at 70%. It moved up to 80% in January of 2008 in an article published by Investors’ Business Daily. Unfortunately for folks who relied on less robust indicators (or none at all), the National Bureau of Economic Research (NBER) did not identify that a recession had begun in October of 2007 until October of 2008 – one year later. By that time, the U.S. stock market had already been crippled by the 2008 stock bear.
There are five forecasting tools that I have traditionally favored for identifying the probability of a cyclical downturn. For simplicity sake, I weight the components equally to come up with a “probability picture.”
Here, then, is my predictive model as it stands in March of 2015:
1. The Institute For Supply Management’s Report on Business. One of the most popular measures of business expansion or contraction is the Purchasing Managers’ Index (PMI). In the broadest sense, a percentage over 50 is indicative of manufacturer health; February PMI came in at 52.9. However, since the Fed backed off of its quantitative easing (QE) in October, the trend has been toward slower and slower growth. PMI percentages came in at 57.9 in October, 57.6 in November, 55.1 in December, 53.5 in January and now 52.9 in February, the slowest growth in 13 months.
With my model considering the trend as well as the static data point, I split the difference; that is, I am awarding 10 percentage points to the “no recession camp” for the actual data point indicating expansion. On the flip side, the dangerous trend that has emerged alongside “de facto” tightening by the Fed also merits 10 points.
2. Conference Board’s Consumer Data. The “Present Situation” Index decreased to 110.2 from 113.9, while the “Future Expectations” Index declined to 87.2 from 97.0 in January. My model evaluates whether or not future expectations are falling faster (if they’re falling at all). If it is falling at a faster month-over-month clip than the present situation measure, it may be indicative of an economy succumbing to recessionary pressures. And indeed, this is the case. The Present Situation Index decreased to 110.2 from 113.9, declining at a rate of 3.2% whereas the Future Expectations Index slipped to 87.2 from 97.0, an accelerated pace of 10.1%. My model awards 20 points to the likelihood of a recession’s occurrence.
3. The S&P 500 Making Lower Lows. This one is not happening at all. In fact since, the October lows, the S&P has marked a series of higher lows in December, January and March. I award 20 to the resilient economy scenario.