Are we now at a turning point — the start of a bear market and economic recession?
The financial markets have experienced dizzying volatility through autumn, erasing the market’s gains for 2018. And now, a new poll shows that nearly half of 212 corporate chief financial officers predict that the U.S. economy will fall into recession in 2019.
While it’s also true that half of the CFOs do not expect a 2019 downturn, 82 percent of them agree that, if the current boom survives 2019, a downturn will hit by late 2020, says Duke University’s Fuqua School of Business, which surveys the CFOs regularly. The financial officers also have a pessimistic outlook for the economies of Canada, Europe and Asia.
But you can draw your own conclusions. The stock market responds to — and signals — changes in the economy. To get a better sense of what’s coming, analysts look at the following important indicators, and you should too.
1. Yield curve inverts
Typically, long-term bonds pay more than short-term bonds. This makes sense: If you agree to tie up your money for longer periods of time, you should be paid more for your trouble. This is why a five-year CD pays more than a one-year CD.
Rarely, however, the reverse is true: Long-term bonds start paying less than short-term bonds. When that happens, a recession often follows. In fact, this situation, known as an inverted or negative yield curve, has proven a highly accurate recession predictor.
Why would long-term bonds ever pay less than short-term bonds? Well, the Federal Reserve controls short-term rates, but the market controls the rates on longer term securities. The Fed can raise short-term rates, which is exactly what they’ve been doing for the past couple of years. But if investors start thinking things don’t look so good in the economy, they keep their powder dry by buying long-term bonds. The more they buy and bid up the price, the lower the rates on these securities go.
As I write this, the yield on 2-year Treasury bonds is 2.75 percent, and the yield on 10-year T bills is 2.91 percent, so the long-term rate is still a bit higher than the shorter-term rate, but the gap has been narrowing. If the yields converge or the 2-year bond yields surpass those on 10-year bonds, that could signal a recession is coming soon.
What to watch: See Treasury yields at the U.S. Treasury.
2. Leading economic index slips
The Conference Board’s Leading Economic Index is one predictor of global economic health. Monthly dips in this measurement aren’t alarming. However, Mark Tepper, CEO of Strategic Wealth Partners, told CNBC viewers in August to watch for a trend of year-over-year drops in the benchmark. According to CNBC, he said:
When it contracts, a recession usually follows.
The latest report shows the index still growing at 5 percent year over year, so there’s no reason for concern right now.
What to watch: Keep an eye on Conference Board press releases or media coverage of the index.
3. Interest rates rise
Government monetary policy can be another economic bellwether. We’ll explain what to watch, but first, a quick refresher on how it works:
The Federal Reserve influences the economy by using a couple of tools. One of those tools is control over short-term interest rates. If the economy is in the doldrums, it can lower rates to encourage consumers and businesses to borrow, buy and invest, which stimulates the economy. That’s why interest rates were kept near zero following the Great Recession that began in December 2007.
On the other hand, if the economy is growing too fast, that can lead to rising prices, otherwise known as inflation. To cool things down, the Fed raises rates, which serves to put the brakes on the economy by discouraging both consumers and businesses from borrowing and spending as much.
While interest rates don’t directly affect the stock market, when businesses have to pay more in interest, that hurts their profits, which will ultimately be reflected in a lower stock price. Also, as rates rise, investors sell stocks, driving prices lower. Why do they sell? Think about it: If you can earn high interest from guaranteed bank accounts or Treasury bonds, why take a chance on stocks?
The Federal Reserve has been pushing interest rates higher in small increments for the past two years to keep inflation in check. Most analysts expect another increase during the Fed’s last 2018 meeting, on Dec. 18-19.
Fed moves, along with the yield curve and Leading Economic Index — the three most important indicators –suggest that there’s still time before a bear market sets in, according to the CNBC report in August. CNBC said:
The three biggest recession indicators are not showing warning signs just yet, so continue to ride the bull market for at least a year.
Money Talks News founder Stacy Johnson agrees.
What to watch: Press coverage of the Federal Reserve Board of Governors’ regularly scheduled meetings.
4. Consumer sentiment falls
Another economic indicator published by the Conference Board, the Consumer Confidence Survey, samples Americans’ “attitudes and buying intentions.”
In November, the survey’s index fell to 135.7, down from October’s 137.9. Still, Consumer Confidence is at “historically strong levels,” according to The Conference Board. So, no worries yet on this front. A trend of falling confidence would be a sign that consumers are growing more nervous about the economy.
What to watch: Track press releases for the monthly report at the Consumer Confidence Survey. The survey is also widely covered in the media.
5. Business confidence cools
Look for signs of trouble in faltering business confidence, says CME Group, a Chicago-based marketplace for derivatives.
Among the risks to business confidence are the ongoing trade war — kicked off by the United States with the imposition of import taxes, or tariffs, intended to give American businesses a bulwark against foreign competition, especially Chinese companies. But the practice tends to spark retaliation — as it has from China, which imposed tariffs on a key American exports — and take a toll on the larger economy.
The current trade war initiated by the U.S. raises the risk of a global recession, CME says, in a discussion of recession warning signs:
First, the trade war disrupts business planning and potentially raises costs related to supply chain management, and in so doing, decreases corporate profits overall (although a few specific companies will benefit). Second, the trade war hurts the Chinese economy and exacerbates the slowdown in growth.
What to watch: Check surveys of business confidence, like the National Federation of Independent Business’ Small Business Optimism Index (down slightly in November but continuing an “exceptionally strong two-year trend.”) Also, Moody’s publishes several economic indicators, national and global.
6. Vanguard’s risk forecast worsens
Vanguard, a massive asset management firm, runs numbers constantly to get a handle on the risk of a recession.
Before the recession that started in late 2007, Vanguard’s six-month forecast had said the probability of a recession in six months was greater than 40 percent, according to The New York Times.
In late summer this year, Vanguard estimated the chances of a recession happening by late 2020 at between 30 and 40 percent, the company’s “highest-ever estimate for that time frame,” the Times reports. That’s a general indicator, not a prediction, Vanguard’s chief investment officer told the newspaper. In fact:
“You could also say the chance of a recession not occurring by the end of 2020 are 60 to 70 percent,” said Fran Kinniry, a principal in Vanguard’s investment strategy group.
In recent years, Vanguard’s six-month risk forecast had been running at about 10 percent.
Are you concerned about your investments or taking measures to deal with risk? Share with us in comments below or on our Facebook page.
Marilyn Lewis and Stacy Johnson contributed to this post.
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