As an investment advisor, staying informed on economic trends is essential to guide your clients through uncertain times. Right now, three major indicators—the yield curve inversion, the Leading Economic Index (LEI), and unemployment trends (specifically, the Sahm Rule)—are signaling potential economic risks.
Here’s what you need to know to properly communicate these trends to clients.
1. Yield Curve Inversion: A Proven Signal
The yield curve, which measures the difference between long-term and short-term Treasury yields, has long been a reliable predictor of recessions. Typically, when the 10-year Treasury yield drops below the 3-month Treasury yield, it points to an approaching recession—usually within the next 12 to 18 months. Right now, the yield curve has been inverted since late 2022, marking one of the longest periods of inversion in recent history.
2. The LEI is Flashing Red
The Leading Economic Index (LEI), which tracks ten critical economic factors like new orders and consumer sentiment, has historically predicted U.S. recessions with accuracy. As of September 2024, the LEI has declined for six consecutive months. This trend, driven by factors such as fewer manufacturing hours and weaker demand for consumer goods, has signaled every U.S. recession since 1959.
3. Unemployment and the Sahm Rule
The "Sahm Rule" is a recession indicator developed by economist Claudia Sahm, who worked at the Federal Reserve and the White House Council of Economic Advisers.
The Sahm Rule, a simple yet effective tool for predicting recessions, flags a warning when the three-month average unemployment rate rises by 0.5 percentage points from its low of the past year. As of August 2024, the indicator stands at 0.57%, meaning unemployment is ticking up, signaling potential recessionary pressure.
4. Additional Factors: Labor Market and Manufacturing Weakness
The latest Job Openings and Labor Turnover Survey (JOLTS) reveals 7.7 million job openings, a dip that suggests labor demand is cooling. While job openings remain high, businesses seem to be moderating their hiring, potentially easing wage pressures. The manufacturing sector, on the other hand, is facing more pronounced challenges. The U.S. Manufacturing PMI is at 47.0 (which is below the crucial 50-point mark), indicating contraction.
what are odds of a recession?
As of September 2024, the outlook for a U.S. recession depends largely on who you ask and how they’re measuring it. Various sources and methods point to different probabilities, with a few key indicators standing out.
Yield Curve: The yield curve, which measures the spread between the 10-year and 3-month Treasury rates, is currently signaling a 61% chance of a recession over the next 12 months. Historically, an inverted yield curve has been one of the most reliable predictors of a recession.
Economists' Surveys: According to a survey by Wolters Kluwer, about 48% of economists expect a recession in the next year.
Bank of America: Their outlook places the odds between 35-40%, reflecting concerns over interest rate impacts on the economy.
Goldman Sachs: They have reduced their forecast for a recession to 15%, indicating more optimism about a "soft landing" where inflation control does not trigger a recession.
Even with these statistics in mind, public sentiment remains more pessimistic, as nearly 69% of consumers believe a recession is imminent.
Recession-Resistant Industries and Asset Classes
Certain sectors and asset classes tend to perform better during economic downturns:
Defensive Stocks: Companies in utilities, consumer staples, and healthcare offer “essential” services, giving them a stable footing when times are tough. iQUANT also points to aerospace & defense as well as discount retailers as industries worth keeping an eye on.
High-Quality Bonds: U.S. Treasuries and investment-grade corporate bonds remain safe choices, particularly as interest rates fall. Long-term Treasuries, for example, gained over 30% in 2008.
Gold: Known for its safe-haven status during times of market stress and inflation.
REITs: Healthcare and residential REITs provide steady income, even in turbulent economies.
Asset Rotation: Mechanically rotating into safer assets can help navigate risk in “risk off” environments.
How about Bitcoin? Bitcoin’s recession performance is hard to predict due to its volatility. Some see it as an inflation hedge, while others link it to market downturns during liquidity crises.
Bottom Line
The prolonged yield curve inversion, falling LEI, and rising unemployment via the Sahm Rule suggest a challenging period ahead. Defensive stocks, high-quality bonds, and safe-haven assets like gold may help reduce downside capture ratios during these times.