Seemingly confirming preexisting concerns about recession among many investors, today an early look at US GDP growth came in surprisingly negative. To be clear, one-off economic declines happen, especially in the first quarter of the year, which is typically the weakest. Whenever recession risk is high or rising, we’ll share a current snapshot of the various indicators we look at. What follows is Hesperian Wealth’s inaugural Recession Watch. As things currently stand, recession risk has definitely risen. Consumer confidence and the stock market recently joined inflation as warning signs. But a majority of indicators remain benign.
Hesperian Recession Dashboard
These eight indicators encompass the major domains of our economy and the behavior of economic participants: Inflation, Consumer Sentiment, Investor Sentiment, Monetary Conditions, Housing, Labor, and a Statistical Model that uses a mix of production, employment, personal income, and sales data points. Historically, only a broad-based deterioration in these measures preceded a US recession.
Each individual indicator can present false signals or provide no warning at all. In fact, some (US stocks, for example) are so volatile as to be useless by themselves but are valuable as confirmatory evidence. Yet we believe—as an ensemble—this group of eight recession indicators can provide an actionable warning sign of an impending fall in economic output, which has serious implications for investments like stocks and bonds that are tied to GDP.
Notes on Recession Risk
The Red Flags
- Inflation is the big concern here, no surprise. It has been for a while. We’ve discussed the different ways high inflation can lead to a recession here.
- But consumer sentiment (as measured by the University of Michigan’s survey) has also now tanked (retail sales and consumer expectations for the future, not shown, are also worrisome).
- US stocks have just turned negative over six months given the year-to-date decline.
The Green Flags
- We see mentions in the financial media that some cherry-picked longer-term interest rate is lower than some cherry-picked shorter-term interest rate (not shown), which is weird, and usually a bad sign. But the spread that probably matters most (the 10-year Treasury yield minus the three-month T-Bill yield) is still in the normal range.
- Homebuilders are quite active and the labor market remains strong.
- Finally, the publicly available “Smoothed Recession Probability” model of Chauvet and Piger shows no recession risk.
Final Thoughts on Recession Risk In General
An investor’s bias should always be toward inaction. It would (and should) take a lot for us to move away from portfolio allocations with decent expected returns. The opportunity cost can be high if we’re wrong. Even if recession risk were high, we’d require at least one other independent piece of evidence to corroborate whatever our Recession Dashboard may be telling us, as it relates to any particular class of investments.
But the idea of managing for risk—the kind of risk that can defer a saving goal or derail a retirement—is founded in economic principles. A portfolio drawdown at the wrong time (right before a large spending goal or around the start of retirement) can have serious consequences for a financial plan.
Recession is one of the biggest risks an investor faces since investments sensitive to economic output make up the bulk of most people’s portfolios. Luckily, many things move in cycles and there are repeating causes and effects. There’s always a chance the future deviates from the patterns of the past. Though, the Recession Dashboard we share has had a reliable track record. We have various concerns about the current investment environment, but for the moment, recession isn’t top of our list.
Eric R. Figueroa, CFP®
I am a Folsom, CA, fee-only wealth manager serving the Greater Sacramento area, California Gold Country, and the nation virtually. I offer financial planning and investment management, specializing in impact investing and personalized values-based investing.
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