We may be in the longest economic expansion in American history, but there are already plenty of warning signs that the next recession may be on its way.
Experts are debating whether a recession is in the cards for 2020 (Fortune reported that 60% of economists think so), or if this expansion has room to run. But one thing is indisputable: several recession warning signals are already flashing.
In addition to the indicators themselves, there's a growing sense that the trade war is long from over, which is weighing on many. Although President Trump announced a pseudo-truce with China, experts are seeing negative implications for businesses and the economy alike. In fact, perpetuating trade protectionism is the "number one issue" fueling business uncertainty, says Mark Hamrick, Bankrate.com senior economic analyst.
To be sure, even those that acknowledge that there are worrisome signs aren't necessarily predicting that a recession is imminent, or even inevitable. Randy Watts, chief investment strategist at William O'Neil & Co, tells Fortune that projected S&P 500 double-digit earnings growth next year and Fed rate cuts are variables that, "if they break positively, ...there's even a chance the economy could re-accelerate.”
In the meantime, here are four signals worth paying attention to.
Recession Probability Index
Since the 1960s, one indicator of a looming recession has been the New York Fed's recession probability index breaking 30%.
The probability of a U.S. recession predicted by the treasury spread hit 32.9% in July—the highest since 2009, according to the New York Fed.
The index in large part looks to the yield curve to determine the likelihood of a near recession. And for Morgan Stanley Wealth Management's chief investment officer Lisa Shalett, the firm remains "cautious" as recession indicators are "flashing yellow," Shalett wrote in a note.
Inverted yield curve
The inverted yield curve has historically been a major indicator that a recession is afoot—and experts believe it's no different this time.
The U.S. Treasury yield curve has been inverted since May—meaning that the three-month Treasury bill (with a shorter maturity) has a higher yield than the 10-year Treasury note (a longer maturity). This inversion is a key signal that a downturn may be on its way. Morgan Stanley notes that, with the 10-year yield falling to 1.95% and the three-month T-bills hitting 2.15%, the "negative spread hit its widest point yet."
An inverted yield curve means that investors have less confidence in older bonds than newer ones, which doesn't bode well. And with this most recent inversion, Chris Dillon, a multi-asset investment specialist at T. Rowe Price, says it "certainly grabs everybody's attention."
Consumer and business confidence
Although consumer confidence is still historically high, the most recent June consumer confidence index (released by The Conference Board every month) dropped to two-year lows, to 121.5. The index provides insight into consumer's concerns, and at these lows, may indicate their growing bearishness on the economy.
"The sentiment measures both for business and consumers should be monitored very closely, because then there’s the question of whether that’s followed by a change in behavior," Bankrate.com's Hamrick says. While he doesn't think consumer sentiment has moved too dramatically, he says business sentiment has dropped from its highs.
In fact, this wavering confidence may be affecting U.S. manufacturing data as well.
"The biggest warning sign has been in contracting [Purchasing Managers' Index], indicating a significant slowdown in expected manufacturing activity," Max Gokhman, head of asset allocation at Pacific Life Fund Advisors, told Fortune in a note. "While U.S. PMIs remain slightly expansionary, in stark contrast with Europe, the trend is decidedly negative."
Gokhman suggests that trade concerns are "paramount to souring business confidence," the escalation of which could "hasten the downturn."
The problem for many analysts is that, with uncertainty over trade policies, businesses may be more cautious with capital expenditures. T. Rowe Price's Dillon describes year-to-date capital expenditures as "disappointing." Whether considering things like building a new plant in China versus Mexico (both targets of trade policy issues) or holding off on investment, William O'Neil & Co's Watts thinks trade is pushing corporate managers to be "nervous about making a corporate capital allocation mistake."
Watts suggests this may be causing undue pessimism about the market given that the consumer economy and employment levels are currently "pretty good." And according to Morgan Stanley, waning business confidence is already having an impact on economic growth and weak earnings.
Weak U.S. manufacturing may be signaling slowing growth—and that's cause for concern.
For Morgan Stanley Wealth Management's Shalett, the most recent economic reports show "slowing that is far worse than the 2015-2016 minirecession," she writes—due in large part to "outright contractionary" PMI (an indicator surveying purchasing managers at businesses) data and global new orders.
For instance, the U.S. automotive sector has experienced slowing sales in recent months, and orders for non-defense capital goods (not including aircraft) fell 0.9% in April—more than expected by analysts. While June PMI Composite (an overview of manufacturing and service sectors) is still above 50 (meaning it's still expansionary), it's dangerously flirting with a drop.
According to a Reuters report in May, factory activity dropped to near 10-year lows, sparking fresh concern. In fact, both JP Morgan and Morgan Stanley cut 2nd quarter GDP estimates to 1% from 2.25% and 1.9% from 2.2% respectively.
Economists like Hamrick are concerned. Hamrick says that the now sub-2% growth pace, down from 1st quarter growth of 3% last year, indicates that the near-11 year economic expansion "should not have been sustainable," and may be overdue for a slowdown.
And as Fed Chairman Jerome Powell noted in remarks Wednesday (which many saw as an assurance for an interest rate cut in July), these trade tensions and the overall slowing of global growth “continue to weigh on the US economic outlook."
For Hamrick, the 30% chance of recession metric shouldn't be too spooky (there's "still a 70% chance that it doesn't happen," he says). But whether or not that 70% chance will hold is yet to be seen, and Hamrick suggests we consider whether we're in for a "soft landing"—or another crash.
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