Turning Points For The Week Of May 6-10

|
Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Hale Stewart
Summary

Corporate credit markets show little to no stress in the funding markets.

Other leading indicators were unchanged this week; the coincidental numbers remain positive.

Due to a flat yield curve, my recession probability for the next 6-12 months is 15%.

The purpose of the Turning Points Newsletter is to look at the long-leading, leading, and coincidental economic indicators to determine if the economic trajectory has changed from expansion to contraction - to see if we're at an economic "Turning Point."

Conclusion: With the exception of the yield curve, the leading indicators are mostly positive as are the coincidental indicators. My recession probability remains at 15%.

Leading Indicators

While not formally recognized as leading indicators, credit spreads typically spike 12-24 months before a recession. This contributes to increases in overall financial risk for which several regional Federal Reserve banks have a measure. Today, I'll be looking at all of these indicators, starting with credit spreads in the corporate bond market.

AAA/Aaa

Merrill's AAA index (left) rose from 2.2-3.8% between mid-2016 and the end of 2018. This move can be seen as much from a "return to normalcy" perspective as a "we're near a recession" perspective. Since the end of last year, this measure declined from 3.8% to 3.2%. The Moody's Aaa index (right chart) has moved more sideways, but like the AAA index, it has moved lower over the last few months. Merrill's BBB index (left chart) increased from 3.2% to 4.8% between 2016 and 2018. Since the end of last year, it declined by about .8% (80 basis points). Moody's Baa index declined from 5.2% to 4.8% since the end of last year.

Finally, CCC yield declined from 13.79% to 11% since peaking at the end of last year.

Partially as a result of declining corporate credit yields, financial stress is lower:

The St. Louis Fed's Financial stress index (above in blue) is near its lowest levels of this expansion. The Kansas City stress index (in red) uses the same components, but is only updated monthly; it should decline in the next report.

The Chicago Fed's leverage index is also at low levels, as is...

...the risk index.

Finally, there is no stress in the short-term funding market:

Short-term commercial paper relative to the federal funds rate is near a five-year low.

Readings of other leading indicators didn't change this week: building permits are softer, but should benefit from lower interest rates in the coming months; orders for consumer and business durables are higher. The equity market did sell-off this week, breaking its recent uptrend, and the four-week moving average of initial unemployment claims rose; both are negative developments. However, the moves are far too recent to support any meaningful conclusions.

The main data supporting my 15% recession probability is the yield curve: The above chart multiplies the 10-year/3-month spread by -1 so that "rising" is actually the negative event. Right now, this spread remains very close to 0. The belly of the curve remains very tight. The left chart shows the 10-, 7-, and 5-year/3-month spreads are fluctuating around 0, while the right chart shows that the 7-, 5-, and 3-year/1-year spreads have been below 0 for a majority of 2018.

Leading Indicator Conclusion: The yield curve is still telegraphing a potential recession. There have been a few potentially negative developments from the equity markets and initial claims numbers, but the data is still too recent. However, the general tenor of the harder economic numbers is for continued expansion.

Coincidental Indicators

There were no new releases on the "Big 4" indicators this week. Here is a chart from the Adviser Perspectives Website which shows all four are still mostly in uptrends:

The only potential area of weakness is the modest declines in real income over the last few months; two of the last three readings are lower. While real sales were a concern earlier this year, it appears to have rebounded over the last few months. And employment's overall growth is very strong and impressive.

Coincidental indicators conclusion: Despite weakness earlier in the year in retail sales and the labor market, the overall tenor of these numbers is positive.

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.