By New Deal Democrat
This is the second part of my 2016 forecast. I withheld this until I had necessary information from the 4th Quarter GDP report. In the first part, I forecast weakness this winter into spring as hopefully excess inventory is liquidated and the industrial recession induced by the strong US$ bottoms.
Geoffrey Moore, who for decades published the Index of Leading Indicators, and founded the Economic Cycle Research Institute (ECRI) in 1993, wrote Leading Economic Indicators: New Approaches and Forecasting Records describing and explaining what he called "long leading indicators," that is, economic metrics that reliably turn a year or more before the onset of a recession. He identified 4:
- housing permits and starts
- corporate bond yields
- real money supply
- corporate profits
A variation of the above is Paul Kasriel's "foolproof recession indicator," which combines real money supply with the yield curve, i.e., the difference in the interest rate between short and long-term treasury bonds. This turns negative a year or more before the next recession about half of the time.
Another long leading indicator has been described by UCLA Prof. Edward E. Leamer who has written that "Housing IS the Business Cycle." In that article, he identified real residential investments as a share of GDP as an indicator that typically turns at least 5 quarters before the onset of a recession.
Finally, Doug Short has identified real retail sales per capita as another important metric. This metric tops out at least a year before the onset of a recession about half of the time.
That gives us a total of 7 long leading indicators. All of these economic series have a long-term history of turning a year or more before a recession. Let's look at them:
Friday's GDP report included 4th quarter real private residential investments (Leamer's indicator). These continued to increase as a percent of GDP, as well as absolutely:
Housing permits are thrown off somewhat by the spike last June due to the expiration of a housing subsidy program in NYC. This did not affect single-family permits. Below, I show single-family permits, and permits ex-NY:
Single-family permits made an expansion high in December, all permits ex-NY in November:
The bottom line is, housing remained positive in the 4th quarter.
CORPORATE BOND YIELDS:
With the sole exception of the 1981 "double-dip," corporate bond yields have always made their most recent low over 1 year before the onset of the next recession. Corporate bonds most recently made a confirmed low 3 years ago. BAA-rated corporate bonds equaled that low, but AAA-rated bonds did not:
Since more than 1 year has passed since even the most recent BAA low, I am scoring this a negative.
REAL MONEY SUPPLY:
No recession has ever started without at least real M1 or real M2, minus 2.5%, turning negative. Here's where they stand now:
These remain relentlessly positive.
When Corporate profits, and their close GDP relative, Proprietors' Income, turn negative, businesses slow and stop hiring, and if the condition persists, start laying people off. We won't have corporate profits for the 4th quarter until at least one more month, but Proprietors' income was reported Friday as part of the advance GDP report, and here it is (blue), along with corporate profits through Q3 (red):
Proprietors' income has continued to increase slowly, while corporate profits did fall in 2015. This is a mixed signal for now.
THE YIELD CURVE:
This is an excellent long range forecasting tool in times of inflation. Typically, a recession begins after the Fed raises rates to combat inflation, sufficiently so that the yield curve inverts.
The yield curve remains very positive now. Still, the yield curve did not invert during the deflationary 1930s and low-flation 1940s, and several recessions happened anyway, so while I am including it, I suspect this is the long leading indicator most likely to signal falsely before the next recession.
REAL RETAIL SALES PER CAPITA:
These peaked a year in advance of both of the last two recessions. Here's what they look like now:
They may have peaked in the 4th quarter, as shown in the close-up of the last year, but of course, it is too soon to tell:
For now, this is a qualified positive.
So, to summarize:
There is only one negative: corporate bond yields.
Positives include housing, real money supply, the yield curve, and with some qualification real retail sales per capita.
Corporate profits vs. proprietors' income are mixed.
This result is not as clear cut as in previous years, not just because there are some mixed signals, but also because it is clear that the strength of the US$ can overwhelm other indicators, and I have no framework to forecast its direction this year. So, while the positives sufficiently outweigh the negatives for me to forecast that the domestic US economy will remain in expansion until the end of 2016, you can throw this forecast into the dumpster if the US$ appreciates at 10% or more YoY as it has since late 2014.