Source Sees More Upside In Us Economy Despite Indicators ‘Flashing Red’ 

Despite leading recession1 indicators ‘flashing red’, Source believes the US economy still has momentum and equity-like assets are set to outperform.

Q3 this year will mark the 29th quarter of the current US economic expansion, which equates to the average length of all previous expansions since 1950. The length has been four to 69 quarters.2

However, there has only been a moderate recovery so far, with a total expansion of only 15.5% since the bottom of the previous recession. The average growth during previous expansions was 31.3%, with a range of 4.4% to 70.8%.2

Paul Jackson, Head of Research at Source, commented: “A sombre interpretation of our analysis is that the indicators are predicting a recession and, as the Fed has limited scope to loosen, it could be quite bad. In this case, treasuries and gold may be the only places to hide.

But given it has been a gentle walk rather than a sprint, it is easy to imagine that the US economy retains some energy. The optimistic interpretation is that the recent weakening of stocks, profits and investment was associated with the weak growth of the last year, rather than with a classic recession.

If that is the case, the fact that wage and price inflation is not excessive, that the Fed is tightening only very slowly and that the yield curve is far from negative gives some hope that this cycle will get a second wind over the coming quarters. If so, stocks will go higher.”

Source analysis shows weakening investment and declines in both US companies’ profits and the stockmarket have tended to precede the last eight recessions and all three have occurred over the last two years. However, they can also emit false signals. For example, stocks have produced 18 such signals since 1951 and profits have done so on 21 occasions and investment 22 times since 1950. Yet there have only been eight recessions over the same period.

However, when these indicators coincide their predictive track record is more consistent. The analysis shows there have been six occasions when all three measures were aligned and recessions followed on five of these occasions. The current situation is different in that the S&P 500 has not had two successive down quarters, although it has been close: the previous three quarters have yielded growth of just 0.9%, 0.8% and 1.4%.

Author: Dylan Jones

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