Recession tracker

Most people associate the performance of the stock market with the Economy. It is a deceiving view of what is brewing below the surface, and unfortunately it is the main reason why most "retail" investors stay too long at the party and are routinely burned through severe market corrections.

The truth is that S&P index of stock prices is only one of the components of the LEI (Leading Economic Index), and while it definitely carries weight, it is not the sole determinant of the overall index. Let's dive into the subject as it will be relevant for our overall analysis of where we stand in the Economic Cycle, and how likely is a recession in the short-medium term.

The ten components of The Conference Board Leading Economic Index for the U.S. include:

Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; ISM Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Index of Stock Prices; Leading Credit Index; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.

Latest read on the LEI

The Conference Board Leading Economic Index (LEI) for the U.S. declined by 0.7 percent in May 2023 to 106.7 (2016=100), following a decline of 0.6 percent in April. The LEI is down 4.3 percent over the six-month period between November 2022 and May 2023—a steeper rate of decline than its 3.8 percent contraction over the previous six months from May to November 2022. The decline is the result of deterioration in the gauges of consumer expectations for business conditions, ISM* New Orders Index, a negative yield spread, and worsening credit conditions

* The Institute of Supply Management (ISM) Non-Manufacturing Index is an economic index based on surveys of more than 400 non-manufacturing (or services) firms' purchasing and supply executives.

LEADING ECONOMIC INDICATORS TREND

INTEREST RATES SPREAD 10YR – 3MO

As we can see from the above data, the outlook seems grim. LEI are in deep contraction and have been for some time, and the yield curve inversion is as deep as it has ever been, not spelling great times ahead.

Now to the point - is the LEI index alone able to correctly forecast a recession, and what would the lead time for one be? Statistically speaking the above picture spells trouble for the Economy. Let's define the Economy even further to understand other data points that need to come in in order to see a recession manifest itself into the larger sections of the economy.

The Economy can be subdivided into three buckets: LEADING ECONOMY, CYCLICAL ECONOMY AND TOTAL ECONOMY

We defined above the LEADING ECONOMY. The LEI Index has turned negative before EVERY recession.

The CYCLICAL economy represents the Manufacturing and Construction sectors and it also turns negative before EVERY recession. It is currently NOT in negative territory. In fact it has been declining since Q1 2022 and has found a local bottom with a slight uptick in the last 3 months. The readings are still weak, and it is very rare for this part of the Economy to not show contraction when the LEI has been contracting for 14 straight months. Let's say that the lag has been extreme so far.

The TOTAL economy is represented by six coincident indicators: Total Nonfarm Payrolls, Employment Level, Real Personal Income less transfer payments, Real Personal Consumption, Real Retail Sales and Industrial Production. When we witness a contraction of the TOTAL ECONOMY, then we are into what Economists define as a Recession.

We are still tracking at a 4.5% growth rate for theses Coincident Indicators, the value of which is being mostly held up by the Employment figures. Real Retail Sales have been contracting for 7 out of the last 9 months, with negative readings for the last four months straight. What is clear is that the consumer has less disposable income caused by the heavy inflationary forces of the last two years.

Summing up:

• Leading Indicators, and especially the inverted yield curve spell trouble for the economy

• Employment picture is still resilient however Initial Claims are undeniably trending up

• The consumer is still spending, however less and via debt accumulation

• Stock Market performing very well and it has a non zero chance to hitting a new ATH, everyone is turning bullish

My opinion is that these are the last few "good months" of what will be a fairly severe downturn. The LEI turned negative 14 months ago. For context during the great Financial Crisis, Recession ensued 16 months after the LEI started contracting and Total Economy growth rate was 5.6% (currently 4.5%).

Can this time the lag be even longer? Absolutely, nobody knows.

It is likely we will enter recession in the next 6 months? Very high probability.

Stay safe out there, and don't be fooled into the "New Bull Market" narrative. The S&P 500 might very well strike new nominal ATH, maybe even shy of 5,000, however the downside here is 30% plus, vs an upside of less than 10%.

THIS TIME IS NOT DIFFERENT!