‘Recession Dashboard’ Update: US Remains Resilient

SUMMARY

• Riverfront believes the probability of recession is lower than market consensus.
• Our ‘Recession Dashboard’ suggests US resilience, with low financial stress and improving leading indicators.
• Labor market and consumer signals are more mixed, however.

With US payroll and unemployment data surprising to the downside two Fridays ago, Treasury markets quickly repriced the probability of impending recession, helping set off a volatility spike in stocks across the world. According to Bloomberg, economists’ consensus probability of a US recession in the next twelve months is now approximately 30%. By diving deep into our ‘Recession Dashboard’ – a mosaic of various indicators that, in our experience, gives insight into impending recession risks – we believe the probability of recession is below what the market is currently pricing in.

Bond Market Signals: Positive — Lack of Stress So Far in the Financial System

We view the fixed income markets — both government and corporate — as a useful source of macroeconomic signals. For instance, high yield credit yields relative to higher quality corporate and treasury securities have risen some recently, but remain benign overall, in our view. The St. Louis Fed produces a ‘financial stress’ index consisting of a composite of eighteen different indicators mostly related to interest rates and fixed income yield spreads (Chart 1, below). This indicator remains well below zero, indicating a lack of financial stress in the system. Last, US loan growth remains positive, suggesting banks continue to have both demand and the risk appetite to continue to provide capital to companies.

But what about the yield curve inversion¹ discussed in previous versions of our Recession Dashboard? Any competent economic forecaster must be intellectually honest about the efficacy of their tools — and anyone solely using yield curves to try and predict the timing of a US recession since 2022 would have been sorely disappointed. The Fed’s unprecedented monetary policy intervention since the financial crisis in 2008 may have decreased the efficacy of this indicator during the current cycle.

Labor Market Signals: Mixed – Valid Concerns… But Not Uniformly Negative

Slowing employment trends can give important warning signals concerning the health of the economy. The weaker than expected payrolls report and the move up to 4.3% in the July unemployment rate caught investors’ attention. However, we would note that more than half of the unemployment increase was related to ‘temporary layoffs’ — a category possibly affected by inclement weather, and one that does not tend to strongly correlate to recession risk, in our view. Helping corroborate this point, other employment-related indicators such as our non-farm payroll tracker — while clearly slowing from 2023’s torrid pace — remains above 1%, a level we view as being consistent with suggesting imminent recession (red dotted line, Chart 2, below).

Consumer-Related Signals: Mixed - Confidence Weak, but Spending Solid

Monitoring the consumer is important, given that consumer spending represents nearly 70% of the US economy. Here the news is mixed. A large drop in the difference between the Conference Board’s Consumer Expectations Index and its Present Situation Index has historically presaged recession, but the lag times vary greatly. This indicator has been in negative territory consistently since inflation flared in the wake of the pandemic. However, in addition to the level of this indicator, we think direction also matters. From a directional perspective, this indicator has been generally trending up (i.e., less negative) since February of last year, as inflation started to trend down. This seems more congruent with strong recent retail sales and personal consumption expenditures (PCE) data, as well as positive earnings and commentary from the largest retailer in the US by volume. Putting the mosaic together, we would currently categorize the US consumer as wary but resilient…particularly among higher earners.

Construction Spending: Positive – More Measured but Growing

Construction plays an important role as a job creator across many industries and as a driver of demand for both natural resources and finished goods. Construction spending grew around +6% as of June, the most recent data release. We track this closely, as construction spending historically has a high correlation to US GDP. Another related data point is yearly heavy truck sales², which are running around 40k units/month…suggesting reasonably strong demand for goods and construction.

Leading Economic Indicators (LEI): Positive – LEI Continues to Improve

The Conference Board’s ‘Leading Economic Indicators’ (LEI)³ is a predictive variable that is designed to anticipate turning points in the business cycle by roughly 7 months. The LEI has now risen consistently since the spring and has now moved above the level which we typically associate with pre-recessionary conditions (red line, Chart 3, below). Other indicators of economic activity we track tell a similarly constructive story; US composite Purchase Managers Index (PMI) readings are still in expansionary territory, and US industrial production recently hit a cycle high. Lastly, we would note that potentially one of the best leading indicators of the economy — the stock market itself — remains only a few percentage points off its’ all-time high made in July…even after the recent bout of volatility.

CONCLUSION: Weight of Evidence Does Not Suggest Imminent Recession

The weight of the evidence in our dashboard points to a slowing US economy in the back half of the year in our view, but not a recession. This is commensurate with a US economy that, according to the Atlanta Fed’s GDPNow tracker, is growing at close to a 2.5% clip for Q3, a little slower than last quarter. While we do not expect as many rate cuts as the market is pricing in, we do expect the Fed to cut in ’24 — a stance underlined by benign recent inflation data such as last week’s lower-than-expected producer price inflation (PPI) and in line consumer inflation (CPI) readings.

While stock volatility is likely to remain elevated into the US election, we believe an growing economy combined with a likelihood of Fed rate cuts should continue to be constructive backdrop for equity investors. We remain overweight stocks, with an emphasis on the US, across our balanced portfolios. However, in keeping with our investment mantra of ‘Process Over Prediction,’ we recognize data can change quickly and we will remain vigilant in monitoring macro risks.

^{1 An inverted ‘yield curve’ – the difference in yield between long-term and short-term interest rates - has historically been a signal of impending recession, as falling long-term interest rates often mean bond investors expect some combination of lower future inflation and growth. When they fall below the levels set by the Federal Reserve, the bond market is suggesting the Fed has raised rates too much.}

^{2 Heavy trucks weigh over 26,000 pounds and include 18-wheeler tractors, cement mixers and city buses.}

^{3 The LEI is comprised of ten indicators related to employment, business orders, residential housing demand, stock market prices and bond market credit conditions.}

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.