3 Recession Signposts To Watch | ETF Trends

Over the last several weeks, investor angst has shifted from China back closer to home. It has become increasingly clear that the U.S. isn’t immune to the global slowdown. Given plunging inflation expectations, a stalling manufacturing sector, a slowing labor market and the Fed’s delay, investors are increasingly asking: “Is the U.S. on the cusp of another recession?”

For now, the recent spate of U.S. weakness appears to be a slowdown, not a full-blown recession. However, the risks to the U.S. economy have certainly gone up. In order to assess the odds of an imminent recession, these three indicators are key to watch:

Recession Indicators to Keep an Eye On

CHICAGO FED NATIONAL ACTIVITY INDEX (CFNAI)

While less well known than the more popular Conference Board Index of Leading Indicators, the CFNAI is the strongest leading indicator I’ve found. Historically, looking at data accessible via Bloomberg, the monthly CFNAI has explained roughly 40 percent of the variation in the next quarter’s gross domestic product (GDP), and its forecasting significance extends out as far as six months. While the index fell sharply in August, it’s still at a level consistent with an expansion, albeit a slow one. However, should the indicator remain consistently in negative territory for the remainder of the year, this would be consistent with the pattern leading into previous recessions, according to Bloomberg data.

ISM NEW ORDERS

In early October, everyone focused on the soft September non-farm payroll report. Investors mistakenly paid considerably less attention to the release of the ISM Manufacturing Survey. In the past, the survey’s new orders component has been a useful predictor of economic growth up to six months forward, as data via Bloomberg show. September’s reading at around 50 is consistent with an expanding economy over the next three to six months. That said, the new orders component has been falling in recent months. A prolonged dip below 50 would raise the likelihood of another recession.

CREDIT SPREADS

Both high yield and investment grade spreads have been widening, with high yield spreads recently hitting multi-year highs, according to Bloomberg data. While spreads are a less reliable indicator than those above, wider spreads indicate rising default risk, which is normally associated with a recession or sharp slowdown.

As of today, all three indicators are sending a similar message: The U.S. economy is likely to expand, but at a slower pace, over the next couple of quarters. While this should provide some relief for investors, this cautiously optimistic outlook comes with a few important caveats. First, these indicators don’t tell us much about the economic outlook beyond the next six months, and no leading indicator has a particularly impressive record spotting recessions more than a year in advance.

Second, while the U.S. may continue to expand, it wouldn’t take much to knock the manufacturing sector into a technical recession. U.S. industrial productiongrowing at less than 1 percent year-over-year, per Bloomberg-has already taken a hit from a strong dollar and weak international growth.

Finally, and probably most important for investors, even if the U.S. avoids a full-blown recession, we may still face a profit recession (two quarters of negative earnings growth). As such, stocks may still struggle, something investors looking to buy the dip in U.S. equities should keep in mind.

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.