RCM Managed Asset Portfolio - Q4 2022

Recession Fears:

    While recessions eventually occur during the course of economic cycles, not all data are good when it comes to predicting the next recession. Some indicators can be poor in predicting exactly when the recession will occur.  For example, the slope of the yield curve is often used as an indicator of a recession. When the slope inverts--when shorter dated yields rise above longer dated yields, the economy is said to be troubled and a recession is to occur. Large parts of the yield curve have been inverted for the last six months which has fed into current investor pessimism.

    Yet yield curve inversions often precede recessions by many months, about 18 months on average. Some less than that. Some of the inversions preceded recession by two years. Lead times vary. So it becomes hard to pinpoint when recessions occur just from following the yield curve. Yet so many use it as a cue to start making portfolio changes.

    While many economists are anticipating a recession, it is not clear that it will (1) come as soon as next year and (2) or that its effects will be severe when it comes to the stock and bond markets, which have already suffered bear markets with no recession having happened. There are other indicators which are better for detecting weakness in the US economy. Some of these we have used in the past. So let’s look at them again to see where they are at now.

    Below is a historical chart of new single-family homes sold. Housing is a large part of the US economy and so it is a good indicator of economic activity and the willingness on the part of households to invest in the future. At the peak of an economic cycle, the number of new homes sold usually exceeds 800,000 to 1,000,000. But then that number starts to go downwards as the economy weakens until it reaches 400,000, at which point the economy begins to recover.  Over the last two years housing has been weakening from 1,000,000 sold homes to its current level of 600,000.

    However, over the last three months the number of single-family homes sold has rebounded slightly. And it is not yet clear whether it continues to decline or that economy necessarily weakens all the way to its lowest limits. We still have a ways to go to before we hit 400,000 homes sold, which would put us in the middle of a recession.

    Another indicator, the industrial production index, would seem to indicate that a recession is getting closer even if it is not yet imminent. Currently, industrial production appears to be peaking as it is no longer going higher but is instead now running sideways. We have said before that the industrial production generally runs sideways before it begins to dip and economic growth begins to really slow. This peak in production is close to the three previous recent highs reached in 2008, 2014 and 2018, which is likely a good indication that we have reached the limit of the US’s industrial supply capacity.

    This would also indicate to me that we will continue seeing lower reports of growth in the near future, following the adage what can no longer go up can only go down. But when down comes is not clear. As seen in the graph above, during the last economic cycle, industrial capacity can vary up and down or go sideways for some time without any clear signal that a recession is occurring.

    Finally, there is one of the best predictors of recession I have found—the heavy truck sales. When heavy truck sales gets above 500,000 and then starts declining rapidly, then we are likely going to face a recession soon. However, that is not what is occurring now.

    When we conveyed this picture last quarter, heavy truck sales were headed in downward direction. So a case could’ve been made then that a recession was right around the corner. But the economy has proven to be fairly resilient as heavy truck sales have rebounded recently. And until it goes down in a significant way, as it has done before every recession shown, it would seem a recession is not yet imminent.

    Overall, there are some mixed signals. While we are set up to have a recession in the future, there is no significant sign that it is coming soon.