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What The Recession Indicators Are Saying About 2020

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by: ANG Traders
ANG Traders
Macro, gold & precious metals, long/short equity, newsletter provider
Summary

Talk of recession has greatly decreased.

We look at a host of indicators, and assess the likelihood of a recession.

Manufacturing and transport is weak, but not a big picture concern.

Deficit spending and SOMA growth will prevent a recession in 2020.

The dominant story during the past 16 months has been one of imminent recession and stock market collapse. The last time we publicly addressed this narrative was six-weeks ago (No Recession Before 2021). Since then, the word 'recession' has almost disappeared from the lexicon of investment writing, and confidence in the stock market has increased significantly. Such rapid flips in sentiment make us sit up and pay attention; they often signal changes in trends. In this piece, we revisit the facts and assess whether the recession narrative has changed, for better or worse.

Labor Data

The non-farm payrolls, although they have been trending generally lower, continue to print within the range that has been in place since 2010 (chart below).

(Source: FRED, ANG Traders)

Initial unemployment claims start to rise at least one-year ahead of recessions. Initial claims are flat-lining at levels not seen since 1969 (chart below).

(Source: FRED, ANG Traders)

A closer look shows that the recent increase was a "one-off" (chart below).

(Source: FRED, ANG Traders)

When we compare the initial jobless claims with the Coincident Economic Activity Index, we see that there is an inverse relationship between the two, where the initial claims increase while the economic activity decreases ahead of recessions. At this time, the indicators are parallel, not converging. This behavior is not indicative of an approaching recession (chart below).

(Source: FRED, ANG Traders)

The unemployment rate tends to cross under the natural (long-term) unemployment rate at either the halfway point, or the two-thirds point of the bull market (blue ratios below). The cross-over occurred in 2017, which means the next bear market would start in 2021 or 2025, depending on whether it is a 2/3 or 1/2 cross-over, respectively (chart below).

(Source: FRED, ANG Traders)

The Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months; the indicator is at -0.7 (chart below).

(Source: FRED)

Business Conditions

ADS Business Conditions Index

The Aruoba-Diebold-Scotti business conditions index is designed to track real business conditions at high frequency. The average value of the ADS index is zero. Progressively bigger positive values indicate progressively better-than-average conditions. The index shows that business conditions are above average (chart below).

(Source: Philadelphia Fed)

IHS Markit US Composite PMI

The IHS Markit US Composite PMI tracks business trends across both manufacturing and service sectors. The Composite PMI was revised higher to 52.7 from a preliminary of 52.2 in December of 2019 and the reading points to the strongest growth in private sector activity in eight months (chart below).

(Source: Trading Economics)

Industrial Production

The ISM Manufacturing PMI in the US fell to 47.2 in December, the lowest since June 2009, from 48.1 in November and well below market expectations of 49 (two charts below).

(Source: Trading Economics)

(Source: Trading Economics)

The ISM Manufacturing PMI pointed to the fifth straight month of decline, and is hands-down the worst economic component. If this was the only indicator that we were looking at, we would be convinced that a recession was unavoidable, but obviously there are many other measures that show the economy is in good shape. For at least 15-years, as a percent of GDP, manufacturing has been steadily declining, and services have been steadily increasing. This means that changes in manufacturing are less importance to the well-being of the economy, just like Alvin Toffler predicted 40-years ago (chart below).

(Source: FRED)

Non Manufacturing PMI in the United States increased to 55 points in December from 53.90 points in November of 2019 (two charts below).

(Source: Trading Economics)

The IHS Markit US Services PMI was revised higher to a five-month high of 52.8 in December 2019 from a preliminary estimate of 52.2 and compared to November's final reading of 51.6 (two charts below).

(Source: Trading Economics)

Industrial production in general has recovered to the top of its 10-year range (chart below).

(Source: Trading Economics)

Transportation

Intimately connected to manufacturing is trucking, which is showing decline in both truck sales and employment levels. While a reduction in this measure seems to be necessary ahead of recessions, it is not sufficient since the 2015 reduction did not result in a recession. The recent reduction is not a concern as long as the majority of other indicators remain positive (chart below).

(Source: FRED)

Housing

The NAHB Housing Market Index in the United States jumped to 76 in December of 2019 from an upwardly revised 71 in November. It is the highest reading since June of 1999 (chart below).

(Source: Trading Economics)

The ten-year view shows that the housing index is at all-time highs (chart below).

(Source: Trading Economics)

Sales of new single-family houses in the United States rose 1.3 percent from the previous month (chart below).

(Source: Trading Economics)

Building permits in the United States increased 1.4 percent in December from a month earlier, and are at a high for this recovery (chart below).

(Source: Trading Economics)

Housing starts in the US went up 3.2 percent month-over-month (chart below).

(Source: Trading Economics)

The ten-year view of housing starts shows that they are close to the decade-long high (chart below).

(Source: Trading Economics)

Housing starts always drop ahead of recessions. They are rising at the moment (chart below).

(Source: FRED, ANG Traders)

The Consumer

The University of Michigan's consumer sentiment was revised slightly higher to 99.3 in December of 2019. It is the highest reading since May and the second best in 2019. The consumer continues to support the expansion (two charts below).

(Source: Trading Economics)

The Johnson Redbook Index measures the growth in the US retail sales, which increased by +7.20% in the week ending January 4 (chart below).

Bank Credit

For some reason, delinquency rates on agricultural loans counter-intuitively drop for a couple of years ahead of recessions. Delinquency rates continue to rise (chart below).

(Source: FRED, ANG Traders)

Ahead of recessions, a minimum of 20% of banks tighten lending standards. Only 5.5% of banks are tightening standards at this moment.

(Source: FRED, ANG Traders)

The health of commercial credit always deteriorates ahead of recessions. Delinquency rates on commercial loans are going down and are close to historic lows (chart below).

(Source: FRED, ANG Traders)

The household debt service-to-disposable income ratio is at all-time lows, and although the delinquency rate on consumer loans has risen from 2.0% in 2015 to 2.34% today, it is still lower than at any other time since record keeping began in 1986. All the hand wringing about America being overly indebted is simply not supported by the facts. Recessions don't start with such healthy consumer credit in place (chart below).

(Source: FRED)

The Bedrock of the Economy

While all the indicators presented above can be considered the "topsoil" of the economy, the fundamental "bedrock" of the economy is the fiscal and monetary support provided by the US Treasury and the Federal Reserve, respectively. As long as the Treasury continues to deficit spend into the economy, and the Federal Reserve continues to maintain healthy levels of liquidity, the economy will not contract. Federal deficit spending creates the National "debt", which despite the mythology (dealt with here), is actually currency creation that funds the private sector of the economy, and which the government as the monetary sovereign, does not need to securitize, but chooses to, for historical reasons. As long as the debt is growing, and as long as the Fed, through the SOMA (System Open Market Account), continues providing liquidity, the economy will not contract; $1.2T of deficit spending in fiscal 2020, along with a growing SOMA will make a recession almost impossible.

On January 7, the GDPNow model estimate for real GDP growth in the fourth quarter of 2019 is 2.3 percent, unchanged from January 3.

Second-Quarter GDP Growth Estimate Steady

The economy is held together by many screws, and not all the screws are tight at the same time, but we think there are enough tight ones to prevent a recession. If it seems reasonable to expect the economy to continue its expansionary ways, then going long the stock market is the logical investment strategy. The simplest way to do this is to buy broad market ETFs such as SPY, QQQ, DIA, and IWM. And for those with a stomach for leverage, they can buy SPXL, TQQQ, or options on the ETFs themselves.

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.