(Discription of chart skip this paragraph if familiar with chart) The axes for the 7 factors in the model are scaled to show the influence each factor has on the model. The lead time of the factors is shown by pushing the data for the factors forward relative to the time scale. The line segments in the factors show the average of the three months that correspond to growth in that quarter. The dots show the annualized rate of growth each month has from the average of the previous quarter.
The model indicates slower growth for Q4 than actually occurred in Q3 but faster growth than the model estimated for Q3. This was the sixth quarter in a row the model indicated slower growth than actually occurred. While this could mean the relationship between the factors in the model and GDP growth has changed from the previous 10 years, I suspect the more likely outcome is that GDP will grow more slowly than forecast in several of the next few quarters. I expect the Atlanta Fed forecast to end up being closer to reality than the consensus of economists.
Weak beginning to 2016
All the data on the chart with a big enough lead time to indicate growth in Q1 2016 shows slower growth than Q4. Real retail sales (orange line and dots) have one month of data pointing to a week start. Oil indicates a weaker start both as a leading indicator (gold line inverted scale) where lower prices are good for the economy and on a concurrent basis (black line) where the price of oil and economic growth tend to fluctuate in the same direction. The data point for January is estimated from daily prices so far for the month. On a leading basis the falling price of oil should become an economic tail wind beginning in Q2.
Industrial production (green line) which has two months of data corresponding to Q1 growth suggests a recession will start by February. It indicates the weakest growth since 2009. The 10 year Treasury yield (blue line) has all the data to indicate Q1 growth and suggests a sharp drop in growth for Q1, reversing the uptick it suggested for Q4.
So with about 47% of the model's data available Q1 looks to be a very weak quarter. Of course, the other half of the data could reverse the prognosis or make it look worse. If Q1 GDP were to come in negative, we still wouldn't know if the data will roll over and show a widespread extended decline. So even if a recession was eventually declared to have begun in January it will be at least 6 months before we know for sure.
Debt and leveraged profits
Corporate debt has reached a level that has led to dramatic declines in earnings in the past. The higher the leverage of debt a company carries the faster profits rise in an expansion and the harder they fall in a contraction.
Debt of nonfinancial businesses relative to GDP is now higher than it was at the start of the Great Recession and almost as high as it was at the start of the 2001 recession. When a recession starts the decline in GDP begins before a decline/liquidation of debt and the ratio temporarily rises further in a recession. If a business is overleveraged going into the downturn it fails.
In the last 15 years the current high level of debt has led earnings to be more volatile than any previous time in history.
In the 2001 recession earnings declined 54% while GDP declined 0.3% from the strongest quarter to the weakest. In the Great Recession earnings declined 92% while GDP went down 4.2%. By Contrast in The Great Depression GDP declined 26% and earnings declined 75%. In The Depression earnings declined a little less than 3 times as much as GDP, while in the Great Recession they declined almost 22 times as much. In the 2001 recession S&P500 earnings declined a staggering 180 times as much as GDP.
From Q3 2014 to Q3 2015 as reported earnings of the S&P 500 declined 14%. Earnings have declined almost to the 35 year trend line. The previous three recessions started about the time earnings fell to this trend line.
GDP weakened in Q3 2015 and will likely weaken in Q4 and weaken further in Q1 2016, if not turn negative. The economy is on the verge of tipping into a recession. While recession seems likely to me it is not certain and we won't know for months.
With the high corporate leverage even a mild recession should send earnings down over 50%. Such a decline in earnings could also send stock prices (NYSEARCA:SPY) down 50%. There is no guarantee the next recession whenever it comes will be mild.
Disclosure: I am/we are short SPY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: There is no guarantee analysis of historical data their trends and correlations enable accurate forecasts. The data presented is from sources believed to be reliable, but its accuracy cannot be guaranteed. Past performance does not indicate future results. This is not a recommendation to buy or sell specific securities. This is not an offer to manage money.