Are indicators pointing boney fingers towards a scary recession?

Trick or treat? — our market spooktacular

Halloween was confusing. All my life, my parents said, “Never take candy from strangers.” And then they dressed me up and said, “Go beg for it."

– Rita Rudner

An Irish myth about a man nicknamed “Stingy Jack” is believed to have led to the tradition of carving scary faces into gourds. According to the legend, Jack tricks the Devil into paying for his drink and then traps him in the form of a coin. The Devil eventually takes revenge and Stingy Jack ends up roaming Earth for eternity without a place in Heaven or Hell. Jack does, however, have a lighted coal, which he places inside a carved turnip, creating the original jack-o’-lantern.

As Halloween approaches, there seems no shortage of ghoulish headlines regarding the slowdown of the U.S. economy. These back-of-the-neck hair-raising tales include:

  • Supply chain disruptions leading to an increase in prices for consumers
  • Risk of rising interest rates and their impact on corporate profits and consumer balance sheets
  • From the middle of August, an increase of nearly 34% in oil prices, measured by West Texas Intermediate (WTI), from approximately $US62/bbl to nearly $US83/bbl as we near Halloween.

The headlines in newspapers and on websites provide no shortage in sights of spooky dangers lurking around the corner for the U.S. economy. Our work would suggest that the U.S. economy is likely to slow down over the next year. But let’s be clear; despite the slowdown, the probability of a U.S. recession over the next 12 months remains very low. Historically, there are warning signals prior to falling into a recession. Some of the signals that we look at are highlighted in the table below. Other than inflationary pressures, we don’t believe that any of the typical signs of a recession are present today. Let’s look at a few of these conditions in more depth.

Recession risk signals

Typical signs of a U.S. recession aren’t present

This table shows seven signs of recession and whether each of those signs is present as of September 30, 2021. Only one of the listed signs is present: positive inflationary trends.
Source: Capital Markets Strategy, Manulife Investment Management, as of September 30, 2021

Leading economic indicators

A metric that we follow closely is U.S. leading economic indicators, as shown in the Leading Economic Index (LEI). The Index consists of 10 economic components whose changes tend to precede changes in the overall economy, including average weekly manufacturing hours, number of new building permits, and consumer sentiment, to name a few. As of September, the LEI registered 9.3. Since 1970, a recession occurred six months, on average, after the LEI became negative, and the most recent figure would suggest a strong and stable U.S. economy.

Here’s a chart that shows the level of the Conference Board's Composite Index of Leading Economic Indicators, from 1976 to September 30, 2021.
Source:  Capital Markets Strategy, Manulife Investment Management, as of September 30, 2021

Financial conditions

Since the beginning of August, the 10-year U.S. Treasury yield has increased from 1.17% to 1.67% as of October 22, 2021, increasing concern that financial conditions are tightening, which tends to have a negative impact on economic activity. In tighter financial conditions, it’s more difficult for corporations and individuals to access credit for consumption. A measure that we follow closely is the Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt, and equity markets within the traditional and shadow banking systems. As the chart below illustrates, this metric turns positive (indicates tighter financial conditions) prior to a recession. As of September, the metric was -0.24 which signals that financial conditions are still very accommodative, and supportive of low odds for a recession within the next year.

This chart shows the level of the Chicago Federal Reserve National Financial Conditions Credit Sub-index from 1971 to September 30, 2021. Credit conditions are currently easy, indicating the odds of a recession are low.
Source: Capital Markets Strategy, Manulife Investment Management, as of September 30, 2021

U.S. employment

Despite a weak September non-farm payroll figure, the employment environment remains constructive. A measure that we follow as a recessionary indicator is the U.S. unemployment rate versus its three-year moving average or longer-term trend.

As the chart below illustrates, when the long-term measure (green line) crosses the short-term measure (blue line) to the upside, historically, it has forecasted a U.S. recession. The U.S. unemployment rate continues to improve, following last year’s recession. There were nearly 10.4 million open positions in the U.S. in August, according to the Department of Labor. And there’s no shortage of news stories quoting employers who say it’s extremely difficult to find workers. Many companies are going as far as offering monetary incentives just to come in for an interview. But with decreasing COVID-19 cases and a decrease in very favourable unemployment benefits, we believe that September’s weakness was a blip and the positive employment trends of 2021 will continue into next year.

This chart shows the U.S. employment rate percentage and the U.S. employment rate percentage three-year moving average, from 1954 to September 30, 2021. The U.S. employment rate has improved since last year’s recession.
Source:  Capital Markets Strategy, Manulife Investment Management, as of September 30, 2021

The one potential signal that our table above suggests is higher inflationary pressures. As we highlighted in our Investment Note, “The inflation train is about to leave the station,” at the beginning of the year, we thought inflationary pressures were less likely to be transitory. Our inflation model suggests that the Consumer Price Index will be more persistent, and will remain above 2.5% into 2022 but will moderate from current levels. We believe this level of inflation will put pressure on bond yields and remains one of the key risks worth watching into 2022. However, inflation between 2.5% and 3.0% without the other signs of a recession over the coming year is unlikely to result in a recession.

Taking advantage of opportunities

How should investors react if the negative headlines influence market returns over the short term? The chart below illustrates the one-year forward turn for the S&P 500 Price Index since 1990 after selloffs of -5% to -10%, -10% to -15%, -15% to -20%, and greater than -20% for all periods — recessionary periods and non-recessionary periods. The bottom line: history would suggest that if we were to experience a pullback, investors have benefitted from buying the dip since we don’t believe we’re likely to be entering a recessionary period over the next year.

Here’s a chart that shows the S&P 500 Price Index one-year forward returns after selloffs from its 52-week peak, from 1990 to September 30, 2021.
Source:  Capital Markets Strategy, Manulife Investment Management, as of September 30, 2021

As the negative headlines surrounding the U.S. debt ceiling, China, oil prices, etc. dominate the front pages, we return to the fundamentals that continue to be supportive of equity prices and recognize that the headlines are all just a bunch of “hocus-pocus!”

Macan Nia, CFA
Co-Chief Investment Strategist
Manulife Investment Management

A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.

Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.

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All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management Limited, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment, or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Unless otherwise specified, all data is sourced from Manulife Investment Management.

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Kevin Headland, CIM

Kevin Headland, CIM, 

Co-Chief Investment Strategist

Manulife Investment Management

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Macan Nia, CFA

Macan Nia, CFA, 

Co-Chief Investment Strategist

Manulife Investment Management

Read bio