Broker Check

Six Key Charts On Recessions

| June 07, 2022

Executive Summary

  • The Federal Reserve and other central banks have begun to raise interest rates to temper global inflation. This restrictive monetary policy will cause global growth to slow, triggering markets to worry more about wavering growth than decades-high inflation.
  • In order to assess whether the U.S. may experience a recession over the next year, we evaluate six indicators of prior recessions. As outlined in Table 1, currently none of the indicators are flashing a recessionary signal yet we will continue to monitor them closely as several have the propensity to do so by year-end.

  • While further volatility in global capital markets remains possible given the uncertainties surrounding the war in Ukraine, the COVID-19 pandemic, and global inflationary pressures, the sustained health of U.S. consumers and businesses along with a robust labor market should allow for continued economic growth over the next year. Against this backdrop, we maintain our conviction in equity market participation while also employing diversification to reduce risk across portfolios.

Chart Content: Differential in yield from the U.S. 10 year Treasury yield and the U.S. 3 month Treasury yield

Chart Significance: It provides an understanding of when economic recessions are most likely to occur. Based on the chart we can observe that recessions follow a yield curve inversion and are most likely in the early stages of a rising spread. Thus, this indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: The Federal Reserve has embarked on an aggressive tightening cycle in order to combat decades high inflation. Therefore, there is risk that the yield curve could invert within the next year if the Fed hikes at their projected pace. In the current environment of a tighter Fed and higher interest rates, equity market participation may prove a better option over traditional fixed income, despite the potential for elevated volatility.

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Chart Content: Differential in yield from U.S. high yield corporate bonds and the U.S. Treasury curve

Chart Significance: It provides an understanding of when economic recessions may occur. Based on the chart we can observe that recessions tend to coincide with a sharp spike in credit spreads. While credit spreads have widened throughout 2022, they remain well below crisis levels. Thus, this indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: The increase in credit spreads has provided opportunities within certain fixed income sectors. Valuations for investment grade and high yield bonds have become more attractive while the risk of defaults has only slightly increased.

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Chart Content: Federal Funds Target Rate versus the Neutral Rate

Chart Significance: It provides an understanding of when economic recessions may occur. Based on the chart, we can observe that recessions tend to coincide with periods in which the Federal Funds Target Rate exceeds the estimated Neutral Rate. The Neutral Rate is a theoretical Federal Funds Rate at which monetary policy is neither accommodative nor restrictive. Thus, it is the short-term interest rate consistent with the economy maintaining full employment and price stability. This indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: As previously stated, the Federal Reserve has embarked on an aggressive tightening cycle in order to combat decades high inflation. While the Federal Funds Rate is currently below the Neutral Rate, the reverse may likely to be true by year-end.

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Chart Content: ISM Manufacturing Purchasing Managers’ Index & ISM Services Purchasing Managers’ Index

Chart Significance: It provides an understanding of when economic recessions may occur. The PMI allows us to see economic trends in the manufacturing and services sectors. Readings above 50 represent expansion while readings below 50 represent contraction. Based on the chart we can observe that recessions tend to follow readings below 50. Thus, this indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: Although the U.S. manufacturing and services PMI readings have declined in 2022, they remain well above 50, indicating continued expansion. Likewise, global PMI readings currently exceed 50. The global expansionary backdrop in manufacturing and services provides further support for equity market participation.

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Chart Content: U.S. Personal Consumption Expenditure, also known as Consumer Spending

Chart Significance: It provides an understanding of when economic recessions may occur. Consumer spending measures the value of goods and services purchased by U.S. residents and is a popular gauge of the economy’s strength given that the reading is a major component in the calculation of Gross Domestic Product (GDP). Based on the chart we can observe that recessions tend to coincide with stagnating or declining consumer spending. Thus, this indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: U.S. households look to be in better shape than ever with strong jobs, wage growth, and balance sheets leading to record consumption. Despite downward trending consumer sentiment, actual spending data suggest consumers are willing to support demand and keep GDP growing, making a recession less likely and providing further support for equity market participation.

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Chart Content: Net profit margins for the MSCI ACWI ex U.S.A. Index (Global Ex U.S.) and the MSCI U.S.A. Index (U.S.)

Chart Significance: It provides an understanding of when economic recessions may occur. Net profit margin is calculated by dividing net income by revenue and provides a summary measure of corporate financial health. Based on the chart we can observe that recessions tend to follow multiple quarters of sharply declining profit margins both in the United States and globally. Thus, this indicator is not currently flashing a recessionary signal.

Potential Forward-Looking Implications: Net profit margins grew at a brisk pace between mid-2020 and year-end 2021 as global economies swiftly rebounded from the sharp recession brought forth by the COVID-19 pandemic. While net profit margins declined both in the U.S. and globally between Q4 2021 and Q1 2022, it is too soon to tell whether we’ve experienced a peak in net profit margins during this market cycle. Regardless, net profit margins remain robust at readings well above their 2000 – 2022 averages.

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Investment advice offered through CX Institutional, a registered investment advisor.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.

All other data, including returns, sourced from Bloomberg, through the release of monthly figures from the Department of Labor, U.S. Bureau of Labor Statistics, or from the Federal Reserve and any of its affiliated regional locations.