After a Decade of Bad Predictions, Here Are 6 Recession Red Flags to Look For
I have five takes on this historical cycle, which can only be labeled as the “no recession decade.”
First, the American bears can’t read data properly. They failed to properly weight specific sectors of the economy. Also, they have major speculative theories on what a particular event means, and they go straight into crash mode right after.
Secondly, the Federal Reserve obsession drove the bears utterly mad this cycle. This typically comes from Gold Bugs, who have had terrible records of being American bearish since 1913. However, they took insanity to an incredible promotional level in this expansion.
My third take: The bears never had a correct diverse economic model for their recession call. I always say, ask a bear for an economic model for their recession calls, and you will get some hilarious answers.
Fourth, political and economic people took financial data and reality so out of context to push their party agenda that anytime any party member said the word recession, it was doomed to fail.
Lastly, we live in a society where doom sells, and it pays to be wrong a lot but speaks loudly. And due to the marketing aspect of this reality, they can’t tell you the truth even if they don’t believe in their logic.
I do have an economic model that has kept me in line from never ushering the song “the Recession is coming.” With all economic models, if you can backtest it to previous cycles, it does give you an excellent reference to work from.
So, here it is, the Six Recession Flag Model. Once all six flags are up, I can then finally say we are officially on the recession watch – that event in itself goes into another great discussion.
The critical factor for this model is that you have to adjust it to the real-time economic, especially concerning demographics and productivity.
Red Flag 1: The Federal Reserve hikes interest rates
This is a no brainer. I do understand why some people thought we might have a double-dip recession with a zero interest rate policy. However, I never agreed with their logic.
Red Flag 2: Unemployment falls down to a certain %
For me, the certain percentage was 4.9%.
In reality, this just means the cycle has moved past the stimulus part, and the labor market is getting a little tight than earlier in the expansion.
These two are pretty simple ones and just move with the economic cycle recovery.
Red Flag 3: The inverted yield curve
This was a controversial call from me.
At the end of 2017, I had forecasted that yields would invert in 2018. I also said that when yields invert, it would be the most prolonged period from the first inversion to the recession ever.
At the end of 2014, I had incorporated bond yield forecasts in my yearly predictions. I have said the same thing every year that the 10-year yield should stay on a channel between 1.6% and 3%.
Naturally, at the end of 2017, with Fed rate hikes in play, I had to forecast an inversion for 2018. I genuinely believe we inverted the yield curve in December of 2018, and I might add that we got three rate cuts after that inversion.
Those are done with.
Now, I am focusing on these three data lines while always being opening to looking at others to see when the recession will happen.
Red Flag 4: Housing starts typically fall into a recession
We did see a slight scare last year at this time as monthly supply spiked up to levels we saw in 1994.
However, this has been the weakest housing cycle ever recorded in U.S. history in terms of new home sales and starts, which means an over-investment thesis in this sector is a tough push running into the best demographic patch ever in U.S. history for housing.
Even after mortgage rates dropped 1.5% from peak to bottom from late last year, we are still down -0.4% year to date on single-family starts. The excess supply created late last year in housing has been brought down to a more acceptable level for starts to grow next year.
Red Flag 5: Leading economic indicators fall 4-6 months straight
This 10-data line series from The Conference Board Leading Economic Index has had a good track record in the past.
However, the more important factor is knowing the components and understand the current cycle. We have had a wave of stronger growth and slower growth in this data line because of its weighting toward manufacturing data.
Each time when growth was falling, people went straight to “the recession is coming.” So far, that hasn’t panned out well for them.
Red Flag 6: Find the over-investment in the economy
The oil shale boom is an excellent example of an over-investment in a sector. The oil rig boom was epic from 2010-2015, and on questionable credit as well. However, when oil prices crashed, so did the oil rigs. It created a manufacturing recession in America in 2016. However, that wasn’t big enough to create a national recession.
Here are sectors to keep an eye on: The auto sector, commercial real estate, and domestic investment data.
One final tip: Outside of the six red flags, look to see credit stress. Credit is part of the leading economic data 10. However, a straight line to track is the St. Louis Fed Financial Stress index. For all the hype of the next depression crash, stress really never showed up here.
St. Louis Fed Financial Stress Index eases lower in the week ending Dec. 13, declining to -1.351 from -1.332 a week prior (normal stress=0).
As you can see above, since 2010, we only breached above normal twice. Even with the PMI recession in 2016, it never got to normal stress.
Now, if you feel more comfortable listening to people who have been wrong for a decade, there are plenty of other sources out there. However, if you want to follow someone who believes in the purity of math, facts, data, you’ve come to the right place.