Hello, I hope this finds you well. Today is Friday, March 16, 2018, and in this blog I will answer the question “is a recession coming soon???”
It’s been a while since I have written about the Five Indicators on a video, and since the bull or up market just turned 9 years old on March 9th, and it’s the second longest bull market post World War II, I thought it would be a good time to give you an update on where they stand. But first, let me remind you what the Five Indicators are….although every economic cycle is unique, LPL Research put these five indicators together to help capture a complete view of the economic and market environment. The indicators are meant to be considered collectively, not individually, and historically can signal a transition to the later stages of the economic cycle and an increased potential of an oncoming recession and bear market. The Five Indicators are: (1) the Treasury Yield Curve, (2) the Leading Economic Indicators Index, (3) Market Breadth, (4) Purchasing Mangers’ Sentiment (or PMI), and (5) Market Valuation. I’ll go through each of them individually.
First, the Treasury Yield Curve is showing no warning. Bull markets have historically ended when the Fed pushes short-term interest rates above long-term rates, which is called “inverting the yield curve”. This indicator is considered one of the most reliable because every recession over the past 50 years has been preceded by the Fed hiking rates enough to invert the yield curve – 7 out of 7 times! If the 10-year treasury stays around what it’s currently yielding, which is about 2.90%, the Fed would have to hike rates roughly seven times to invert the yield curve by 0.5%, so this may be about two years away, assuming the Fed hikes by .25% each time.
Second, the Index of Leading Economic Indicators or LEI is showing no warning. This indicator is also considered reliable at providing early warnings of recessions and bear markets. When the year-over-year change has turned from positive to negative, a recession has typically followed within the next 14 months. The latest reading for January 2018 rose 6.2% over the past 12 months signaling a low probability that a recession will cause a bear market in the next year.
Third, Market Breadth, is showing no warming. Market breadth, which is measured by the number of stocks advancing versus declining, gives us a sense of how broad and durable a market rally may be. The late 1990s provides a great example, when the tech sector was the only thing holding up the market. Currently, the NYSE Composite Advance/Decline line shows no major warning signs.
Fourth, ISM’s Purchasing Managers’ Sentiment, is showing no warning. This index shows demand for manufactured goods, and historically has been a good earnings indicator. As earnings are the most fundamental driver of the stock market, this index can show when economic activity may be slowing. The February reading of 60.8 was the highest since 2004 and significantly above 50, which is the level that indicates contraction.
The fifth, and last indicator is Stock Valuations which is the only of the five indicators on watch. It is important to note that this indicator has been on watch for a while now, and that stock valuations have not historically been effective short or intermediate investment timing tools. That said, price-to-earnings or PE ratios, which measure the price paid for a share relative to the annual profit earned by the company, may be able to tell us when the stock market may be more vulnerable to deterioration in the economic cycle. The S&P500’s trailing PE ratio is around 20, down from 23 at the S&P500 peak on January 26, 2018.
In conclusion, despite it’s old age, broadly these indicators give us confidence that we may be celebrating the tenth birthday of this bull market one year from now.
Thank you for taking the time to read this, and as always, if you have any questions, please feel free to reach out.
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The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Barclays Capital Aggregate Bond Index, which used to be called the "Lehman Aggregate Bond Index," is a broad base index, maintained by Barclays Capital, which took over the index business of the now defunct Lehman Brothers, and is often used to represent investment grade bonds being traded in United States.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.