A Simple And Easy Great Recession Watch By The Tracking-Examining-And-Accounting ('TEA') Approach

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Summary

The no.1 enemy to investors, emotions, can be controlled by permanent asset allocations. No.2 enemy is Great Recessions (“Black Swan” or “White Elephant”).

Great Recessions (GRs) can be watched with The 'TEA' Approach - Tracking ('T'), Examining ('E'), and Accounting ('A'). The Approach is Simple and Easy.

Tracking GRs by the Negative-2-Q-GDP rule. Examining GSs by the Inverted Yield Curve. Accounting GRs by the Coupling-Equity-and-Bond-Price Signal.

No approach is perfect, but going with on is better than without. All investors must do is to take time to check about 10 economic and market data.

My article (A Simple But Winning Strategy: Permanent Asset Allocations In Extremely Volatile Markets) would be one of the most reliable investing strategies not only for its primary target investors who are in mid-60s or older but also for the younger by adjusting the strategy a little bit as recommended in the last part of it.

The main message of the article is that the strategy would help you overcome your No. 1 enemy - your own emotions. As a long-term investor on the time horizon anywhere between five and seven years, what would be the No. 2 enemy to you? Perhaps it would be a Great Recession ("GR") like the one in the previous one, started in December 2007, according to the dating of the National Bureau of Economic Research (NBER), which is called the NBER recession.

"A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and whole-retail sales." ("Detecting Recessions in the Great Moderation: A Real-Time Analysis, Troy Davig, Economic Review of the Kansas City Fed, Q-IV, 2008, p. 8)

A recession starts at a peak of the economy and ends a trough of it. The economy expands between trough and peak. A recession is normally brief while an expansion is the normal state of the economy with different lengths from one upswing and another. Long-term investors ride on expansions. Therefore recessions are their primary concerns.

The methods of dating peaks or troughs of business cycles have been continuously developed and improved since 1920 when NBER (led by Wesley C. Mitchell and Arthur F. Burns) was formed: NBER's first business cycle chronology was published in 1929. NBER's Business Cycle Dating Committee determined the peaks and troughs since 1929: First unofficially from 1929 to 1978 and officially after 1978 when Martin Feldstein of Harvard University and the President of NBER officially established the Committee.

"The Business Cycle Dating Committee discusses announcing a peak or trough when a sufficient amount of data [has] accumulated to suggest a turning point. If the committee [agrees] that the economy has passed through a peak or trough, then it issues an announcement giving the month and year of the turning point. Since its inception, the committee has not revised any of the original announcements regarding the dating of peaks and troughs." (ibid., p. 9)

"[T]he…turning point decision…was on July 7, 2003, when NBER announced a trough occurred in November of 2001." (ibid., p. 10, the emphases are mine) NBER announced about 20 months after the trough because NBER wants to make a correct timing rather than timely. Even though NBER compiles a solid historical record, policy makers businesses, and investors need other methods to detect recession signals as quickly as possible.

"The business cycle tracking model can be used in different ways to extract a signal regarding whether the economy is likely heading for a NBER recession. One method uses a rule-of-thumb that signals whether the economy is 'in' or 'not in' a condition that will likely turn into a recession. The second method generates a probability that provide a signal of 'how likely' it is that the economy is heading for a recession." (ibid., p. 6)

The Chicago Fed National Activity Index ("CFNAI") is a real time model to get a signal for turning points of economic activity. This model is really reliable, using 85 separate economic series. Other Federal Reserve Banks and several private companies also developed this kind of computer models. Some outcomes are seen in various sources including Seeking Alpha.

What NBER Business Cycles Dating Committee and other Business-Cycle Models are doing (with various economic data, indicators, composite indexes, diffusion indexes, and sophisticated forecasting methods) is, however, not far away from the work of Geoffery H. Moore, as documented in his seminal book in 1980. (Business Cycles, Inflation, and Forecasting, (Ballinger: NBER)

Moore's work is also not quite different from the works of Burns and Mitchell in the 1920s and 1930s when Burns and Mitchell submitted a number of series (which would be fairly reliable indicators of business cycles) to Henry Morgenthau, Jr., the Secretary of the Treasury in 1937; The list was published in 1938; The list was revised in 1950, 1960, and 1966.The list originated the system of leading, coincident, and lagging indicators which are used by NBER, Conference Board, BCD (Business Control Digest), and many Business Cycles Models.

The questions are: Why the list of indicators developed about 80 years ago is still useful and why some indicators are a member of the current business cycles models. What the NBER Dating Committee cannot date turning points timely with so many staff and so may series and well-developed computer models. Why the Fed cannot forecast the economy and business cycles more accurately.

The simple answer is that business cycles and economic activities on the aggregated level are extremely complex and delicate because multi-level interactions among all industries, all different regions, and all sectors with different time lags to adjust the impacts of economic policies - monetary and fiscal - and other geopolitical disturbances, and natural damages, and so on.

The challenge on determining durations, amplitudes, and scopes of business cycles never has been abated. It has been strengthened from cycle to cycle. Burns and Mitchell defined that "a cycle consist of expansions…followed by…recessions; this sequence of changes is recurrent but not periodic: in duration business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximately their own." (Geoffrey H. Moore, Business Cycles, Inflation, and Forecasting, (Ballinger: NBER, 1980), p. 14. The emphasis is mine.)

Burns and Mitchell collected data, analyzed business cycles, and dated turning points in economic and market activities, mostly with paper and pencil. This way still can competes with the business-cycle models, backed by the advanced technology, and far-well-developed computer software, and the abundant data and indicators.

The starting tool is the rule-of-thumb, indicating that the continuation of the negative growth rates in the real (inflation-adjusted) Gross Domestic Products (GDP) in two consecutive quarters would begin a recession. The problem of this method is real GDP: It is not monthly data. The quarterly number is available with a long time lag. Also it is inflation adjusted.

Now, however, two reliable sources are available: ""[T]he Federal Reserve Bank of Atlanta, which has published its own regularly updated GDP estimate, GDPNOW since July 2014…GDPNOW takes 13 subcomponents that go into GDP…" ("Fed Fights Itself Over GDP Data," The Wall Street Journal, April 13, 2016, p. C1) The New York Fed's FRBNY Staff Nowcast started April, 2016. As a result, we can use these two GDP growth rates every week.

Take Great Recessions ("GR"), not garden-variety recessions which are usually brief: The GR nine years ago was a rare bird, Black Swan ("BS"), as described in my articles (The Federal Reserve Doesn't Blink This Time, The Market Does & The RED Spread: A Market-Breadth Barometer - Can It Predict Black Swans?), because it was completely not anticipated. The coming GR would be a Mammoth Beast like White Elephant ("WE") because we remotely expected when the impact of the Brexit would not contained in the U.K. but it would spread internationally over seven years (through the whole negotiation process with the European Union), damaging the global credit and banking system as what happened before.

What should we do? Wise sailors prepare for coming storms when sea is calm, so do prudent investors when markets make all-time highs. After the July 23 Great Britain referendum and our election, we would be a cross road of sharing a big pie with higher growth and free trade on one direction, and of protecting smaller pie with lower growth and isolationism. Neither direction is easy drive. The U.S. election is a huge wild card.

Step 1: Tracking GR by the negative two Quarters ("N2Q"), referring "T". You should check GDPNOW of the Atlanta Fed or Nowcast of the NY Fed or both. You may take either estimate or the average of both. Currently any negative estimates for two quarters in a row are not anticipated within a couple of years. Even when we have a N2Q, don't jump to a conclusion that we have a GR. That's why the following two steps are needed.

Step 2: Examining GR by the inverted yield curve ("IYC"), referring "E". My article (The Treasury Normal Yield Curve: The Fed Operates On The Curve Routinely But It Has Been The Conundrum To The Markets) explained that the IYC would lead a recession in several months ahead. All you have to do is simply to view the Treasury yield curve in the Wall Street Journal at least every month. Now the curve is a little bit less stiff than last year, but the convex shape makes it stronger than a straight upward one. (View ibid. for details) When the curve becomes somewhat flat or inverted, the GR signal from "T" might be verified or expect the GR signal in a near future.

Step 3: Accounting GR by the coupled Equity and Bond prices ("CEB"), referring "A". The necessary and sufficient condition of GR ("BS" or "WE") and a market crash is that stock prices and bond prices are coupled with a sharp plunge of both, and a surge of trading volumes.

"Typically, the turn in stock prices occurs prior to the turn in business activity. Hence stock prices are said to lead the swing in the business cycle, and stock price indexes are 'leading indicators'…" (Moore, ibid., p.185) Therefore, a CEB would lead a GR with one caveat: A case that the former would ensue (or not precede) the latter may not be ruled out because a GR is not a typical recession.

When the stock market crashed (even though with a slim chance), investors (in particular retired investors) should decide whether their life-time savings in their portfolios move to the cash-equivalent such as Treasuries (about 1.5% on the 10-year T-note), money market funds,(about 0.1%) or "high-yield" online Savings (about 1%).

The "TEA" Approach, combining the three steps ("T", "E", and "A"), is Simple and Easy to Watch Great Recession. No approach is perfect but going with an approach is much better than with no approach at all. Pay your continuous attention on GDPNOW, Nowcast, The Treasury Yield Curve, The 10-year T-note yield, The Dow Industrial Average, The S&P 500 Stock index, The Nasdaq composite, BND (Vanguard Total Stock Market ETF), VTI (Vanguard Total Bond Market ETF),SCHZ (Schwab U.S. Aggregate Bond ETF), and SCHB (Schwab U.S. Broad Market ETF).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.