Worries about the yield curve inversion continue to linger, but what are other leading indicators showing? Financial Sense Newshour spoke with Simon White at Variant Perception to get his take on forward-looking data.
Visit Starting to See Tremors Across Various Asset Classes, Says VP's Simon White for podcast audio.
Take Inversions with a Grain of Salt
Variant Perception used to place a heavy emphasis on the yield curve’s predicative power. Now, White pointed out, there are several drawbacks to relying on it as a forecast tool. The lead time between an inversion and the onset of an actual recession is highly variable, he stated, anywhere from four to six months to two years before a recession takes hold.
As a de-risking signal, inversion is essentially useless. Additionally, in this cycle everyone is acutely aware of the yield curve inversion based on its notoriety as a predictive measure. This further blunts its usefulness, White noted.
“The yield curve has almost become a bit of its own worst enemy,” White said. “The yield curve inversion is interesting, and it probably does tell us that recession is coming, but whether that recession occurs in four months, 12 months or even further out, I can’t say.”
Other Leading Indicators
White’s work focuses on identifying other leading indicators to derive insight into market direction and predicting recessions. Variant Perception built several models, considering Fed regional surveys, credit spreads and various economic inputs. Each data point is useful by itself, but their power is best realized together, White noted, creating a much stronger signal.
Recessions do not occur in a linear fashion, but rather feature a rapid shift from a non-recessionary state to a recessionary state. White believes the best we can do is to say that over the next four to five months either a recession has a very low probability of happening or a very high probability of happening.
“Where we are today, our recession signal is quite dormant,” White said. “It's telling us that there's a relatively low probability of a recession over the next three to four months. The key thing to note—especially at this point in the longest postwar expansion cycle on record—is that this can change very quickly. You've got to be very nimble and very alert.”
Caution Now, Recovery Later
We’re now starting to see fallout from the Fed’s pivot earlier this year, White stated. The risk-reward ratio of owning equities is very low right now which keeps him cautious on equities. In the absence of any real recession risk, it's difficult to become excessively negative on equities, he added. Rather, think about hedging positions at this point.
Leading indicators point to a slowdown in global growth through 2018 and into 2019, White added. The rest of the world is further through the process than the U.S., White stated, and the slowdown in global growth is beginning to level out.
U.S. growth is already at its low point, White noted, and he expects to see growth in the rest of the world start to relatively outperform U.S. growth.
The trade war with China is likely to be drawn out, with no clear or quick solution in sight. When we look at these factors together, we can start to make some assumptions, White stated. Global trade correlates very well with global growth, so as trade falls expect to see global growth continuing to roll over.
We're already seeing this fall in global trade, he noted, and leading indicators have pointed to that already. The U.S. and China are stuck in a zero-sum game, White noted.
“There's probably not going to be a quick resolution here,” White said. “The possibility of larger flare-ups is possible because the stakes are higher in a game of chicken than in something like the prisoner's dilemma.”
2020 Pick Up in Global Growth
White noted at the 12-month horizon leading indicators have started to turn up. This is primarily due to much easier monetary policy across the world, thanks to the Fed moving to an easier stance. Over the last six months three or four central banks have raised rates, but about more 20 of them have cut rates, he added. This represents a sea change in global monetary policy outlook.
“We should expect to see green shoots toward the end of the first half of 2020,” White said. “However, if we keep seeing this downturn in global trade, things could get worse before they get better, and we will have to temper these green shoots. Monetary policy should help us avert a global recession.”