The Four Recession Indicators


Rising Rates and Flattening Yield Curves

Rising interest rates and a flattening yield curve are some things to be concerned about. While the current situation is not dire, inflation is rising and the yield curve is flattening. If these two indicators continue to deteriorate, it might precede a recession. However, our strategic portfolio management in San Diego can help you make a data-driven approach to your finances. Continue reading to learn more about San Diego financial services and our recession indicators.

A recession, as defined by the National Bureau of Economic Research (NBER), is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Unfortunately, these are all lagging indicators and the NBER can’t officially declare that a recession has occurred until afterwards. This, of course, does not stop nearly every economist or portfolio manager from predicting when the next recession might occur, even if it is a foolhardy endeavor.

Nonetheless, if there is no perfect formula or algorithm to predict such an event, this doesn’t mean that there aren’t a few great leading indicators to consider when looking for potential trouble on the horizon. Here are my 4 favorite indicators:

Four Recession Indicators

Slower Consumer Spending
Rising Unemployment
Inflationary Pressure
Inverted Yield Curve

Consumer Spending and Employment

Consumer spending represents ~70% of the U.S. economy and is quite possibly the most important U.S. economic indicator. Our country is strong due to our consumption and we depend on this fact greatly. As things currently stand, consumer spending is extremely strong.  Typically, during a recession, consumer spending drops by more than -1% via a monthly change. The latest reading shows a monthly growth rate of +0.35% 

Regarding the employment reading, we just saw the unemployment rate drop to its lowest rate (3.8%) since 2000.

Unemployment rate
Source: Bull Oak Capital

Most individuals in the work force have a job and wages are finally starting to increase. In fact, employers are having a difficult time finding enough workers to fill their demand. Needless to say, the U.S. looks very strong. And this is true with a backdrop where the rest of the world seems to be slowing.

Rising Inflation

Inflation levels, which have been rising from their lows in 2015 after briefly dipping below 0.0%, are currently at 2.43%. Modest inflation is generally good for an economy. Rapid inflation or deflation can be devastating for an economy. The Fed has a 2.0% target inflation rate and it looks as if we have finally reached and surpassed this figure.

Core CPI has been rising

In response to rising inflation levels, the fed will raise interest rates to temper this growth. In addition to real inflation rising, expected inflation has also been rising.

inflation expectation

Should this be concerning? Not really as things are not out of control. Though, it is worth keeping an eye on. If the Fed is forced to take a more aggressive stance on rising inflation, the capital markets (including equities) and the overall economy will feel the price.

Flattening Yield Curve

A yield curve is a curve that shows interest rate points across several maturity dates. Most commonly plotted chart is the US Treasury bond yield curve due to its importance in the economy (after-all, it is the largest and most widely-held security in the world).

A normal yield curve will show a normal risk appetite among investors (lower rates among shorter maturities and higher rates among longer maturities):

normal yield curve

However, the yield curve has been flattening, meaning that the gap between short and long-term treasury rates has narrowed.

Flattening Yield Curve

Another way to determine if the yield curve is flattening is to measure the gap between the 10-yr and 2-yr Treasury rates.

10 to 2 yr Treasury Spread

As you can see, nearly every time that the spread has inverted (dropped below 0.0%), a recession has occurred (shaded area on the chart). The current 10-2 yr Treasury spread is 0.43%, down from 2.66% on December 31, 2013.

Conclusion

Some would argue that because the yield curve is flattening and inflation levels are rising, it should be a time to panic. However, it is worth noting that the yield curve has not yet inverted and inflation levels are not out of control. There is no need to ring any alarm bells at this point in time. Even if the yield curve does invert soon, this is still only one indicator, albeit an important one, out of the 4 recession indicators I mentioned above.

Research shows that actively attempting to pick individual stocks and trading frequently does not bode well for the investor. Here at Bull Oak Capital, we believe in passive investing (via low-cost ETFs) and maintaining globally diversified. We adjust our portfolios major asset class exposure based upon the risk characteristics of the global markets. We do this while helping our clients build and maintain a comprehensive financial plan. If you feel like you could benefit from a portfolio review or if you would like to learn more, please feel free to contact us.

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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.