Last month, I made a preliminary long leading forecast through the end of 2019: "Preliminary Long Leading Forecast For 2019: Recession Watch Beginning Q4".
Since that time, the remaining Q4 2018 series I was waiting for have been published, and we’ve also gotten several important metrics for January 2018. Because these materially affect the forecast, I am doing an update now.
To recap, here was the summary of my preliminary forecast:
- We have 3 negatives: interest rates, housing, and credit conditions.
- We have 2 positives: corporate profits and real retail sales per capita.
- We have 2 mixed indicators: money supply and the yield curve.
Update: Long leading indicators that had been delayed
The long leading data series that have been updated are:
- Real private residential fixed investment from Q4 GDP
- December (and January) building starts and (especially) permits
- Proprietors’ income from Q4 GDP
- Real retail sales for December (and January)
With only one exception, these either confirm a negative trend or revise a trend downward.
Let’s start with the positive development. Corporate profits after taxes deflated by unit labor costs was identified decades ago by Prof. Geoffrey Moore as a long leading indicator. These are usually reported in the second version of the GDP report, but in the first calendar quarter, they aren’t reported until the final installment (i.e., at the end of March). As a placeholder, I use the usually compatible proprietors’ income metric. Those increased in the 4th quarter of last year:
Between this and the positive Chicago Fed Financial Conditions indexes, the producer side of the economic ledger looks quite positive for the rest of this year.
But on the consumer side and in the housing market, the story is different. Real private residential investment as a share of GDP declined again in Q4, whether we measure it nominally or in real terms:
Meanwhile, there have been mixed results in December and January building starts and permits:
All of the rebound in permits has come from multi-family dwellings. The less-volatile single-family permits metric made a new 12-month low:
Even though interest rates have backed off, and there is some evidence that sales prices have as well, and even if the housing market bottoms in the course of the next few months, the downturn in housing over the last 12 months is likely to put continuing downward pressure on the economy for the rest of 2019.
Finally, real retail sales per capita have also peaked 12 or more months before the last few recessions. As of this morning’s retail sales report for January, not only have we not had a new high in the last two months...:
... but we have actually seen YoY real retails sales per capita turn slightly negative for the last two months in a row.
Going back all the way to 1948, and including the predecessor real retail sales metric (red in the graph below), with only four exceptions - 1951, 1967, 2002, and summer 2006 - negative YoY real retail sales per capita for at least two months in a row have immediately preceded each recession:
Despite this negative YoY reading, because the downturn from peak has only been for two months, the rating on this long leading indicator goes from positive to neutral.
Thus, the summary for my long leading forecast changes to the following:
- 3 negatives: Interest rates, housing, and credit conditions.
- 1 positive: Corporate profits.
- 1 neutral: Real retail sales per capita.
- 2 mixed indicators: Money supply and the yield curve.
In sum, with more complete information, the “Recession Watch” call centered on Q4 2019 remains, and in fact, has received more support. To reiterate, treat this in a similar way to a “Hurricane Watch”, as if the 5-day forecast cone for the hurricane included your area. There is an enhanced chance of the event occurring, but not a sure thing unless the conditions continue - in this case, the long leading indicators do not quickly reverse, and the short-term leading indicators turn negative for a sustained period of time.
At this point, there is also a specific caution that the government shutdown affected lots of economic activity, and so, a number of them - most importantly real retail sales per capita - could rebound in February.
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.