By Kostya Etus, CFA, CLS Investments, Senior Portfolio Manager

“The past can hurt. But the way I see it, you can either run from it or learn from it.”

– Rafiki, The Lion King (1994)

A potential slowdown in the economy and the prospect of a recession has been a hot topic lately. Let’s take a closer look at some of the key economic indicators to figure out how close we may be to a recession. Further, we will evaluate the ever-important question: If a recession does come about, what will it mean for the markets?

To help me illustrate my points, I will use a couple of beautiful charts from Capital Group, a great partner of ours and fund manager for the American Funds.

WHAT ARE THE SIGNALS THAT INDICATE A RECESSION IS NEAR?

Here are four economic indicators that can warn of a recession:

Inverted yield curve

While some parts of the curve have inverted, the more commonly referenced 2-year/10-year yields have not inverted. Even if they do invert, there are typically 16 months that follow before a recession starts.

Corporate profits

S&P 500 earnings may have peaked in the third quarter of last year, but there is a whopping 26-month lag on average before a recession.

Unemployment

This is at some of the lowest levels in history; nothing to worry about here.

Housing starts

Millennials are slow to move out of their parents’ basements – housing starts are flat.

There are also aggregated metrics, such as the Leading Economic Index, which has been a reliable predictor, and it is not flashing any major red signs.

CONCLUSION: A REVIEW OF KEY ECONOMIC INDICATORS AND THE AGGREGATED LEADING ECONOMIC INDEX DOES NOT SUGGEST A RECESSION IS COMING ANY TIME SOON. BUT THESE INDICATORS DO SUGGEST THE BEGINNING OF SOME WEAKNESS IN THE ECONOMY.

Equities-typically-peak-01-768x370

BUT EVEN IF THE RECESSION DOES HAPPEN, WILL IT REALLY BE THAT BAD?

Recessions are typically infrequent and short-lived, and they appear as small blips when looking at the big picture. They represent only 15% of all months evaluated.

Because some of the strongest stock rallies happen in the late stages of a recession, the average S&P 500 return during a recession is actually positive.

We believe that investors with a long-term investment horizon are better served staying diversified and invested.

CONCLUSION: RECESSIONS CERTAINLY DON’T APPEAR AS BAD WHEN YOU COMPARE THEM TO THE STRENGTH AND LENGTH OF HISTORIC EXPANSIONS. A KEY TAKEAWAY IS THAT AVERAGE MARKET PERFORMANCE DURING RECESSIONS HAS ACTUALLY BEEN POSITIVE.

Kostya Etus, CFA, is a Senior Portfolio Manager at CLS Investments, a participant in the ETF Strategist Channel.

0950-CLS-7/31/2019

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