On The Lookout

Are we headed for a recession?

Photo: Dee Golden. Source: Morguefile

The short answer is, nobody knows. Recessions happen with surprising regularity in an advanced economy, but predicting them is challenging. Stocks are down right now, and this has people worried that the economy will turn down and stocks will fall even further. After all, stocks lead profits which lead the economy. So the equity market is a leading indicator, but stocks have predicted 9 of the last 5 recessions. They fell dramatically in 1998 and 2011, and a lot of folks panicked. That was a mistake, and when the market recovered to new highs, they got whipsawed. Equity prices are just too jumpy to use alone as an indicator.

On the other hand, some economic factors do lead the economy. For example, people don’t build houses or buy new cars when things look bad. When you combine financial and fundamental factors, you can get a sense of whether we’re headed for a downturn. The Conference Board’s index of leading economic indicators provides this kind of picture, and it’s been around for decades. What is it showing?

Leading Indicators. Source: Bloomberg

So far, the index is still turning up. It’s been a pretty reliable advance predictor of recessions; it turned down in 1999, in early 2000, and in 2005—well before the stock market crashed. And it didn’t break down in 1998 or 2011, the most recent market scares when there a lot of (what turned out to be) false sell-signals. If you had sold out at those times, you would have missed out on a couple years of double-digit returns.

So—based on this index—it looks like we’re going to be okay—that the latest turmoil in China or downturn in oil prices or rise in the dollar won’t knock the economy off track. That doesn’t mean that the market is fairly valued, or that we won’t see a period of low returns or that the Fed won’t get stuck with low interest rates. But it does mean that the chances are that the economic tide will keep rising.

And a rising tide should keep floating all of our boats.

Douglas R. Tengdin, CFA

Chief Investment Officer

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