- The Leading Economic Indicators Index provides a great snapshot of overall expectations for the economy
- Since 1956, the Treasury yield curve has inverted in front of every U.S. economic recession
- Based on these indicators, the odds are statistically low for a recession in 2017
Economic recoveries and expansions do not die of old age. Rather, they end because of tighter monetary policy or a shock to the economic system. Absent a disaster, the economy usually hums along. Nevertheless, there is constant demand from investors for updates on the status of the economy.
The Leading Economic Index
Two indicators, in particular, can give the quickest read on whether a recession may be near. One is the Conference Board Leading Economic Index (LEI). The LEI provides a great snapshot of the overall health of the economy and has historically picked up inflection points in data trends that offer advance warning of a recession.
The LEI is an aggregate of 10 diverse economic indicators. It has components and data on such factors as employment, housing, manufacturing, bond yields, and consumer expectations. When the year-over-year change goes from positive to negative, a recession generally follows within a year. The LEI signal has historically had an average lead time of six months.
The LEI is encouraging in today’s environment. It was positive at December 31, 2016, and has risen further in 2017.
The yield curve
An indicator that has proven even more reliable at signaling an upcoming recession is the yield curve, or more precisely, an inverted yield curve. The curve inverts when short-term bond yields rise higher than longer-term bond yields. Most of the time, long bond yields are higher because of the greater risk associated with waiting many years for the principal to be repaid. This relationship can change when short-term rates are raised too aggressively or when long-term expectations deteriorate. An inversion of the curve has been a harbinger of every economic recession since 1956 — 10 out of 10 times.
The good news today is that the yield curve is not inverted. While the difference between the 2-year and 10-year yield has narrowed since the Fed’s Open Market Committee (FOMC) raised the federal funds rate twice in the past year, it is still positive.
Recessions deserve attention
Why is the recession question so important? Because the average cumulative decline for the S&P 500 during a recession is approximately 39%.
The issue for investors is never whether a recession is coming. In a sense, a recession is always ahead, as no economic expansion lasts forever. The question to consider is whether a recession is at hand.
Today, based on the weight of the evidence, the odds are statistically low for a U.S. recession in 2017 and the beginning of 2018.