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Consumer-Led Recession Still Looks Unlikely

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by: New Deal Democrat
Summary

Most recessions in the past half-century have been consumer-led.

There have been a series of reliable precursors to a pullback by consumers.

Several months ago, I concluded that those precursors were not showing that a consumer-led recession was near.

An update to those precursors indicates that while one has turned, there are still several nearly perfect ones that remain positive.

So, a consumer-led recession still looks unlikely for now.

Introduction

Several months ago, I looked at precursors to a consumer-led recession, and in a separate article set forth the order in which historically consumer behavior has turned prior to a consumer-led recession. Last week, I updated my look at precursors to a producer-led recession.

This post updates my look at consumers.

The mechanics of a consumer-led recession

To reiterate what I wrote several months ago, the typical order leading up to a consumer-led recession has been:

(1) interest rates rise;

(2) the yield curve inverts;

(3) lending standards tighten;

(4) motor vehicle sales decrease, usually by 10% or more;

(5) durable goods sales generally decrease; and finally

(6) real retail sales overall decrease

before a recession starts.

In other words, if a yield curve inversion ultimately telegraphs a consumer-led recession, typically the process appears to be transmitted through a tightening of bank credit to consumers, which shows up in a decline in consumer purchases of vehicles and in consumer durable goods purchases generally, and then, finally, retail sales turn negative YoY.

As of several months ago, I concluded that while parts (1) and (2) had occurred, (3) was only neutral rather than truly negative, and (4), (5), and (6) had not tipped over yet.

While interest rates have come down, and the yield curve has almost entirely righted, that doesn’t mean the danger of a consumer-led recession has entirely passed.

So let’s start with item (3): lending standards.

Historically, the first metric to turn is an increase in interest rates on consumer loans. The data with the longest history is for 48-month motor vehicle loans. Over the past 40 years, a cumulative increase of 1.5% or more has always been followed by a recession within 7 quarters, with the sole exception of the 1995 slowdown:

This threshold was met in Q1 of this year.

Bank unwillingness to lend to businesses has also been a consistent precursor of recessions after a yield curve inversion:

As of Q3 of this year, this turned negative - although not nearly as intensely as before the last few recessions.

Meanwhile, bank hesitancy to lend to consumers is now at levels seen before the last two recessions (as far back as the data goes):

So, item (3) on our check-off list has been met.

Next, let’s compare light vehicle sales (red) with real durables spending on vehicles, adjusted for inflation (blue). Note the first is the dollar spent, whereas the second is the numbers bought:

These have tended to move in tandem, and turned significantly negative in advance of any recession. While they did turn slightly negative earlier this year, they are both now flat. A close call, but this metric has not deteriorated as much as it has before any recession in the last 40 years.

Next, here is real durable goods spending by consumers generally:

With the sole exception of the 1981 recession caused by a steep hike in interest rates, this metric has turned negative YoY at least one quarter, and usually more, before the onset of a recession. As is obvious, that isn’t the case now.

Finally, once all of this has happened, we get to the nearly infallible metric that typically appears about one quarter before the onset of a recession - a negative YoY change in real retail sales:

As of the October report last week, real retail sales YoY deteriorated to only +1.3%. It has by no means turned negative.

Conclusion

Since my last report on this topic, item (3) of the order set forth in this procession has turned from neutral to slightly negative, while items (4), (5), and (6) have all either remained positive or improved from slightly negative to flat.

In short, the consumer remains alright, at least for now.

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.