Leading Indicators Not Suggesting Imminent Market Peak, Recession

Mon, Jul 24, 2017 - 4:17pm

Several skeptics responded to our piece last week looking at the yield curve as a leading indicator (see Yield Curve Not Suggesting Imminent Market Peak, Recession) by saying that the yield curve is no longer reliable because of the Fed’s distortions on the market.

This was essentially the same view given by Bill Gross in his July newsletter where he wrote: “the reliance on historical models in an era of extraordinary monetary policy should suggest caution.” Gross highlighted the yield curve as a specific example.

Assuming the yield curve has lost its predictability, what is the message coming from other leading indicators?

One we cite regularly on our site and podcast is the Conference Board’s US Leading Economic Index (LEI), which has averaged a 6.5 month advance warning prior to recessions since 1965. It is a composite of ten different indicators and, as they write on their website, is “designed to signal peaks and troughs in the business cycle.” It is currently at a 4% annual growth rate (positive growth in green, negative in red) and, in agreement with the yield curve, is not warning of a major market peak or recession in the US (click any chart to enlarge).

Here is a look at the same chart from 1998 to present with the S&P 500 shown underneath. Major bear markets most often occur during recessions (red vertical bars) preceded by a contraction in the Conference Board’s LEI.

Another leading indicator is financial stress. Various regional Federal Reserve banks have financial stress composites that measure default risk, financial market and bond volatility, yields spreads, and other variables. Financial stress tends to increase (move into the red zone) prior to recessions and also helps to warn of a possible peak in the stock market. Currently, financial stress is quite low.

In terms of US employment, a decline in temp hiring (shown in blue) has also been a reliable warning signal for an oncoming recession. Temp hiring almost went negative in 2016 but has since rebounded and is now growing at 4.7% year-over-year (nonfarm payrolls is shown in orange for reference.)

Lastly, another leading indicator we like to follow is jobless claims. It tracks the number of people filing for unemployment benefits and, as you can see below, tends to see a major uptick heading into a recession. Currently, jobless claims are still in a downtrend and have yet to surge higher.

Until these and other leading indicators we follow deteriorate, the risk of a recession and/or major market peak appears to be low. That said, as we discussed with Barry Bannister at Stifel Nicolaus (see here) and Caroline Miller at BCA Research (see here) on our program recently, given the shift in monetary policy and other expected headwinds, there is a good case to be made that the US stock market will be facing pressure next year with a possible recession around the 2019 timeframe. We will be covering this and more in our upcoming Investment Strategy and Wealth Preservation Conference this October in San Diego, California. For more information about this event, please click here.

Bottom line: Leading economic and financial market data still lean bullish when it comes to the cycle's primary trend. However, as Jason Goepfert at SentimenTrader recently discussed on our program, key measures of investor sentiment are at frothy levels, which raises the risk of a near-term correction over the next 1-3 months (see Rydex Trader Bullishness Surpasses 2000 Tech Bubble).

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