Reflections [Expanded version]
Is the U.S Yield Curve Inversion locked in?
In our February 2019 commentary we forecast that the 10’s and 1’s yield-curve would invert in May. The data below is taken from that market commentary, with a warning that the indicated dates of recession have a very wide standard deviation over the historical record:
The 10’s and 1’s term spread has been inverted since 23rd May, for six sessions now. The question that naturally comes to mind is “how long must the daily yield curve be inverted for us to have a “latch“?”
The chart below shows daily 10’s less 1’s yield curve prints since 1962:
Apart from brief 1-day inversions on 21/09/1998 and 05/10/1998 there have been no inversion spells that have not ultimately led to full-blown sustained inversion very shortly thereafter. Our preferred granularity is on the weekly level, which at six days inversion has now been met.
Assuming prior daily history holds, one would be inclined to assume the 10’s and 1’s yield-curve will remain inverted or if not, will remain inverted in the very near future.
However, in a past commentary we observed that once more than 60% of the treasury yield-curve spectrum inverts, the remainder invariably all invert in very short order. It is probably more useful to examine the entire treasury term-spread spectrum to try and assess where we are:
At this point in time we are bouncing on that 60% level with just the 10’s and 2’s, the 10’s and 3’s, the 10’s and 5’s and the 5’s and 3’s (the traditional inversion laggards) above water:
And herein lies a clue as to why this time things may be different – the ones above water and some of those already below water are actually widening their spreads! This could quite well shape up to be a false positive as witnessed in 1999 when only 60% of the treasury spectrum inverted.
The longer the 10’s and 1’s (and all the others that currently are inverted) remain below zero, the higher the odds of a sustained inversion but for now we are still 40% short of a full spectrum treasury term-spread inversion.
There is of course one more question we need to start answering and that is assuming the yield curve remains inverted or does so in short order, will this lead to recession? There are two camps at the moment:
- Those that ridicule the “this time is different” arguments, noting that every time in the past things we proclaimed different they were anything but;
- Those that argue that the negative real interest rate policy of the Fed and other forces causing today’s inverted yield curve are entirely different from those in the past.
We have seen some pretty compelling arguments from the “this time is different” yield-curve camp and of course there have been prior inversions that have NOT led to recession (see 1966) and we will therefore be observing many other long-leading indicators less influenced by the Fed and artificially low interest rates to come to our determinations. Any recovery in the residential housing market index (USHMI) should be watched as well as the current situation of all the other long leading indicators in the Monthly Leading Economic Index (USMLI).
Conclusion : A definite yellow flag for the treasury yield curve spectrum is up, but given only a 60% inversion, we do not think the red flag for the full yield curve spectrum is up yet.
Unemployment is worse than it looks
The U.S civilian unemployment rate reached new lows of 3.6% in April – numbers last seen 51 years ago in 1968:
There are a number of ways to use the national unemployment rate to signal recession, but almost all of them are co-incident to slightly lagging in the warning they provide.
We have the most commonly used method which is annual growth of the unemployment rate, which has provided about six false positives since 1950 and can lag on occasion due to the long time frame it uses – although it provided timely warnings in the last 3 recessions:
When national unemployment rises more than 0.5% in an economic expansion, it usually signals the start of a U.S recession without any pesky false positives. If we assume 3.6% was the low then this implies a unemployment rate greater than 3.6%+0.5% = 4.1% will be our warning signal:
We prefer to examine the state-level unemployment data which tells us about what is going on “under the hood” of the national unemployment rate. The three metrics we prefer to look at all provide earlier warning signs than the traditional methods and are covered in our monthly Labor Report for subscribers. Here is last months’ reading:
We notice that all three metrics are showing a lot more underlying deterioration and loss of momentum than is currently observable from the national unemployment rate itself. In fact, since March 2014 these metrics have all been climbing steadily, as they did in the prior 5 recessions.
It’s unfortunate that accurate state-level unemployment data is only available going back to 1978 to provide longer term history but this does not detract from the usefulness of these indicators to get a more sensitive reading into what is happening with unemployment.
Despite the visible deterioration in the state-level data it is not panic time yet. More states have to have rising unemployment than those with falling unemployment for the one metric (green line) and both the other two metrics need to stay above 50% before we start hitting the panic buttons.
What are odds of a SP500 reversal?
The SP-500 has corrected 4.35% from its recent high achieved a couple of days after our repeated warnings of high correction risks. The question that naturally comes to mind now, as we embark on this corrective phase, is what the odds of the worst being over are.
We have been working on a statistical model for launch in July but due to the topical nature of this question, we thought we would reveal what the current version of the model is saying. The statistical model leans off daily closing price data for the SP-500 since 1963 and works off short, medium and long term corrective phases taken over 10, 60 and 240 trading sessions respectively. It then examines how much we have currently corrected over these respective periods and what percentage of the respective historical samples led to the corrections becoming worse. The inverse of this percentage can then imply the statistical probability of the correction being over.
It sounds ridiculously simple and is a work in progress, as we are combining with other factors such as duration of correction and so forth, but it is proving useful nonetheless in assessing short, medium and longer term trading or entry risk over the long term history. The idea is that it is used in conjunction with our other trough-detection models such as Great Trough Detector (GTR) etc.
Anyhow here is the latest reading where the odds of a short term bottom are just shy of 90% whilst the odds of a medium term bottom being witnessed are just shy of two-thirds and a longer-term bottom only at 52.1% Ideally we want all three these figures North of 80% or even 90% to keep the odds in our favor but the longer-term corrections visit these levels far less frequently so short term traders will be more aggressive in their use of the short-term probabilities.
Whilst we are on this topic, note that GTR is now flirting with deep trough territory (but that could change intraday):
Also the Selling Pressure Diffusion Index is on a heady reading of 6:
Finally, the Net-new-highs which gave timely warnings is on zero and a rise above 0 signals a BUY (slower than the other models but still useful):
So we sit and wait…
Global Growth Roundup – 4Q2018
NOTE : The following charts are extracts from our monthly Global Economy Report available with a standard subscription.
Global Economic Activity slowing at the fastest pace since 2011
The cumulative GDP growth for the 4 quarters of 2018 for all 41 major countries covered by the OECD display a stark contrast between the best and worst performers:
The G20 and U.S are comfortably above the OECD average, whilst the EU is uncomfortably below average, no doubt due to low growth from the German and Franco blocs. Argentina is surprising given the low level of press afforded such shocking growth numbers, whilst India overshadowed China. The battle between India and China is interesting if you look at the below chart:
China has been steadily declining, whilst despite recent weakness from Q2-2016 for India, her trend is still up.
Looking at the major GDP-weighted trading blocs is also interesting with BRICs and EM naturally at the top of the pile and G7 below the OECD average since Q1-2015. Of note is how South Africa, a member of both BRICs and EM, is a perennial under-performer of these two trading Blocs.
Here is a look at the quarter-on-quarter GDP growths. Canada, Germany, Portugal, U.K and Russia are all flirting with a potential negative Q1-2019 print given their current trends. Also of interest is how the whole of Europe (representing 25.8% of global GDP) is flirting with stagnant GDP growth and a possible negative GDP print for Q1-2019. Apart from Argentina we see that economic powerhouse Italy with roughly 3,2% of global GDP is in technical recession as well as Turkey.
All the GDP data is heavily lagged and rearward looking. For higher-frequency co-incident monthly data we like to examine total World Economic Activity that looks at both Trade Volume (average of imports and exports) and Industrial Production, as taken from the CPB World Trade Database. It is clear that Total World Economic Activity is slowing at the highest pace in a decade, despite a welcome improvement in January 2019 (click for larger views)
The main culprits are Europe, the Emerging Economies and the entire Africa & Middle East bloc:
So we have seen the lagging data (GDP) and the co-incident data (Economic Activity) and none of it looks great. What lies ahead for the future? The country-level Leading Economic data is not that promising either. We are already in a well established global economic business cycle downturn and while there have been recent promising signs from the percentage of countries posting rises in their LEI’s (a leading indicator of the World LEI) it is still too early to be proclaiming any global business cycle troughs:
The prognosis is that we should expect things to get worse before they start getting any better on the global stage. In light of the (rare) warning we issued a while back regarding U.S stock market valuations, it is our opinion that it would be prudent for U.S investors to err on the side of caution for now, despite what any US stock market rallies dish up to the contrary.
The U.S bond market seems to concur, with some 60% of all potential term-spreads having inverted already:
Note that once the yield-curve complex starts inverting, it rarely un-inverts itself. Despite this stark warning, remember that it is a single long-leading indicator with significant variances in lead times to historical recession which makes it far less useful to the market-timer than meets the eye.
NOTE : The above charts are extracts from our monthly Global Economy Report available with a standard subscription.
U.S Stock Market Valuations continue to warn
We have updated the RecessionALERT Valuation Index (RAVI) forecast models for the SP500 using 4Q2018 data. Stock market valuations continue to pose a “clear and present danger” to positive economic and SP500 returns outcomes, and have worsened since our last warning .
One and two year SP500 forecasts continue to offer relatively accurate short-run estimates despite their low overall long-term correlations and both are foretelling mediocre returns (click image for larger view):
To this end, as is tradition, we offer SP500 forecasts to end 2019 as follows, taken from your dashboard, with the understanding that despite relatively surprising accuracy the last 4 times we did this, one-year ahead forecasts can vary significantly from actual outcomes:
Of more concern however is the continued deterioration of the smoothed-RAVI forecasts which are used as market timing signals with 3 quarter ahead warnings. You can view these on the CHARTS>MACRO>RAVI tab
At this point in time the only major vectors of concern from our universe of models are that over 60% of available term-spreads have inverted (bar the 10yr complex) and that valuations are beginning to get close to sounding the alarm.
We would remind you however that recession (and stock market) forecasting is more art than science – if it were that easy, everyone would have seen 2008 coming – and we maintain that a battery of diversified indicators and models need to be monitored and taken into a investment decision making process. Two models in the more than dozen we maintain for clients is likely not robust enough to base investment actions from.
Yield curve inversion forecast update – Feb ’19
Based on the methodology discussed here we hereby update our U.S Yield-curve inversion forecast and subsequent recession and stock market peak forecasts. All the forecast dates have moved foward by 1 month as the yield curve continues to print below its regression mean:
We have inversions on all the typical early inverters:
- 5’s and 3’s,
- 5’s and 2’s,
- 5’s and 1’s,
- 3’s and 2’s
- 3’s and 1’s
- 2’s and 1’s.
What is of interest is that once the yield curve complex starts inverting, invariably all of them land up inverting, bar one case in 1999.
Whilst there is currently high interest in the yield-curve for predicting or forecasting recessions, remember that it is a single long-leading indicator with significant variances in lead times to historical recession which makes it far less useful to the market-timer than meets the eye. These rough guidelines in the tables above are provided to highlight these wide variances and assist you to guage the major inflection points to watch.
World in depths of business cycle slowdown
On 8th June 2018 we penned a warning that the worlds’ major 41 economies, as tracked by the OECD, were headed for a synchronized business cycle slowdown.
You can read the article here : World headed for cyclical slowdown.
Indeed, as you can see below, for quite a few months shortly afterward, we bottomed out with less than 11% of the 41 countries tracked having rising OECD LEIs:
The percentage of 41 counties with a rising LEI seems to have bottomed though and as this is a leading indicator of the global leading indicator, the assumption may be made that perhaps the worst is nearly over. A couple of more months and we will see.
WLEI updated and some news
We seem to be revising down each week but the overall shape of the WLEI still hints at an index attempting to put in a bottom and recover.
For several quarters now we have been working on getting additional high frequency weekly leading economic data incorporated into the WLEI. It is a lot easier said than done but we are close to the final release of WLEI2 which has 20% more discrete weekly components. What we like about it is that none of the components rely on any shut-down federal agencies which means it should be fairly impervious to an extended government shutdown.
There are very few weekly leading US economic composites that remain pure to their mandate of only using weekly published data, that have not suffered from false positives in the last two business cycles, so WLEI V2.0 is looking very promising.
Have a good weekend.
Dwaine van Vuuren.
Yield curve inversion forecast update – Dec ’18
Based on the methodology discussed here we hereby update our U.S Yield-curve inversion forecast and subsequent recession and stock market peak forecasts. All the forecast dates have moved foward by 1 month:
Yield Curve Inversion Forecast Update Nov 2018
Based on the methodology discussed here we hereby update our U.S Yield-curve inversion forecast and subsequent recession and stock market peak forecasts. All the forecast dates have moved further back by 5 months:
Stocks valuations pose “clear & present” danger.
Those clients who have been with us since 2010 will know our refrain from issuing unnecessary and/or sensationalist warnings about the economy and markets. In fact, in 2012, the general consensus was that the US economy was about to fall back into recession, a view we opposed to quite some ridicule from certain quarters.
Whilst we see no immediate danger signals from the econometric models (apart from the narrowing yield curves in the bond market) we do see danger posed by current stock market valuations. Now stock market valuations have been touted as offering “clear and present danger” for the last 3 years running from several quarters except ours, so this is the first time this business cycle we are joining that clarion call. But using different models we might add.
Our model of choice when measuring risks (or opportunities) posed by US stock market valuations is the RecessionALERT Valuation Index (RAVI) which you can read about over here. The RAVI data for 3Q2018 has just been updated and is available in the CHARTS>MACRO>RAVI tab where you can review and verify the information we provide below.
Our main tools with the RAVI to assess long-leading stock market peak warnings are:
- The 4-quarter average of the 1-year SP500 forecast,
- The average annualized forecast from the 1, 2 and 3 year forecast models
- The 8-quarter average of the 2-year SP500 forecast.
These are shown below, where it is evident why we are sounding the alarm on valuations:
The RAVI 1-year (3Q18 to 3Q19) and 2-year (3Q18 to 3Q20) forecast for the SP500 are depicted below:
Whilst the r-squared values are very respectable for such short-run forecasting models, it is the act of the forecasts turning negative that is of more interest, since these foretold the last two recessions and subsequent stock market crashes. Both are firmly in the red.
Given that the models run 1-quarter in arrears, and the SP500 Total Return actually topped in 3Q18, it is quite feasible that we have witnessed the stock market top already. But if not, it just means that the valuations become even more stretched in 4Q2018 – a situation that could persist for up to a several quarters (or not). One thing we cannot deny though – the business cycle is clearly in the sunset stages.
There is one big “yes, but…” with these models. We only have an accurate track record of two recessions, whilst all our other econometric models have at least 6 , sometimes 10 on their track records.
What makes this model a particularly interesting addition to our arsenal though is that it is completely different to all the others and is the only metric we have that looks at valuations themselves as a trigger for recession.
In summary, a stock market correction is more likely to be triggered by overvaluations at this point in time than by concerns about the economy. Caution is advised.
2nd derivative of WLEI posts warning
The RecessionALERT Weekly Leading Economic Index (WLEI) is essentially a first derivative indicator (rate of change). We can create the second derivative by measuring the percentage of time the WLEI has historically spent above the current reading. The history shows us that this is a good leading indicator for another WLEI metric, namely the percentage of WLEI components in recession territory (we call this the “WLEI Diffusion”):
The 2nd derivative is diverging from the WLEI Diffusion, and as we mentioned, in the past when this has occurred, the Diffusion eventually is forced to play catch-up.
This implies more structural damage could be ahead for the WLEI, that is not just limited to a deterioration in its levels.
The components of the WLEI currently in recession are all related to the corporate bond market (AAA/BAA etc.) The Credit spreads market composite and the labour market composite are looking impervious at this stage. This leaves any further damage to the Diffusion likely to originate from the stock market or the Treasury/Corporate bond spreads composite.
Another useful leading indicator for the WLEI is ECRI’s own WLI, which confirms that more damage ahead for the WLEI is likely:
The ECRI WLI can lead the WLEI on many occasions, as it is composed of some longer leading and/or more sensitive indicators than the WLEI.
When we constructed the WLEI our focus was less on longer leading characteristics and more on less “false positives”. As you can see from the chart the WLI has had 4 false positives so far this business cycle versus 1 for the WLEI. It’s a good pairing for high frequency leading data – you take the ECRI WLI as the 1st warning and the WLEI as second. If both are flagging recession, which looks increasingly likely in the next few weeks, you obviously need to take note and start consulting the more robust monthly models or the SuperIndex which is composed of many monthly models.
SP500 was ahead of itself but tailwinds could be back
During the 6 months running from March to September 2018, the SP500 was running counter to the seasonal average returns profile of the 4-year U.S Presidential Cycle:
It appears the seasonality averages eventually got their way and the SP500 fell hard in October 2018, in what was supposed to be a strong month. In all likelyhood the tailwinds of one of the strongest periods in the Presidential Cycle will come to bear and we should expect good returns for the next 8-10 months.
Below is a slightly outdated (as of 2016), but no less relevant, statistical analysis of the Presidential Cycle. We have just entered the 2nd month of the “PowerZone” which is the 11th month of the Mid-term year.
The height of the bars represent the average gain for the month, and the percentages within the bars represent how many of the months posted gains, followed by the gain/loss ratio. So for November 2018, the 2nd month of the “PowerZone”, we expect an average return of 2.5% with a 78% probability of a positive gain this month. The gains from the winning months in the 2nd month of the “PowerZone” outpace the losses 4.6 times to 1.
January 2019 promises to be the most powerful month of the entire 4 year cycle, with greater than 4% gains and a heady 93% winning percentage. The model suggests a dose of leverage between now and August 2019, although I prefer to scale back any leverage beyond April 2019.
The historical returns from the above suggested strategy of buying on 2X leverage from the 10th Month of the Mid-term year, selling in the 8th month of the pre-election year, and buying again with no leverage in the final month of the pre-election year and then selling again at points “SELL-A” (best winning ratio), “SELL-B” (best return) and “SELL-C” (most in the market) are simply astounding. In fact, I am not even going to bother putting them up for display lest your glasses become too rose-tinted.
Yield curve inversion & recession forecast
There is naturally a lot of focus on the U.S yield-curve at the moment, as it moves relentlessly toward inversion (when short-term rates are higher than long-term rates.) Can the history of the yield-curve inversion provide for useful forecasting as to the start dates of the next U.S recession?
The 10’s vs. 1’s yield-curve and U.S recessions in the post-war era are displayed below, where it is clear that the nine recessions since 1956 were predicted by yield-curve inversion, with one false positive in 1966.:
The chart below shows how many months the yield-curve inverted before each of the recessions. We ignored the false positive in 1966 to give the yield-curve the benefit of the doubt. The smallest lead-times to recession average 8 months, the median lead-time is 12 months and the longest lead-times average 20 months:
So all that is required now is to project the current yield-curve trajectory into the future to see when it will invert, arriving at a date of February 2019:
From this projected inversion date we can make some estimates on when we are most likely to see the arrival of a U.S recession based on the average short lead-time, the median lead-time and the average longest lead-time to a recession:
Now it is accepted that the U.S stock market is a forward-looking indicator and will peak before the onset of a recession. Sure enough, in our 2012 research note: “Recession: Just How Much Warning Is Useful Anyway?” we showed that any generalized stock market defensive actions 5 months before the onset of recession are likely to prove unproductive, based on the last 5 recessions. This would imply we need to start preparing for a U.S stock market peak around the following dates:
There is a lot of commentary around the yield-curve no longer being an effective recession warning indicator due to the artificial low-interest rate environment created by the FED. There is also the timeless stock market quip that when you start hearing that “this time is different” that things will turn out anything but different. There are a lot of theories as to why an inverted yield-curve for even short periods will guarantee a recession, but the one that made the most sense to me follows:
“Banks make longer-duration loans to clients who pay the longer term rates. These loans are the assets of the bank. Depositors lend money to the bank at the short-term interest rate. These are the bank’s liabilities. When the bank pays a higher rate on its liabilities than what it earns on its assets, it loses the incentive to forward more loans to businesses and stops lending. This causes a “credit crunch” or the falling availability of credit. Businesses struggle to roll over their current account credit and they are forced to downsize and lay off workers, and we enter a recession. The moment the Fed engineers short-term interest rates to go below long-term interest rates, the banks can generate a profit again, credit expansion will resume and the stock market and economy can recover.”
If one assumes the above narrative to be true, then it doesn’t matter how low the interest rate environment currently engineered by the FED is – when short-term rates are higher than long-term rates a credit crunch, stock market peak, and recession is inevitable.
We can make some interesting observations by measuring the area under the yield-curve when it is above and below zero respectively as depicted below:
We note that it does not take a lot (as measured by cumulative inversion area below zero) to trigger a credit crunch and recession. We can also deem the area above zero as representing “excess liquidity” and quite clearly the area of the current credit-easing cycle dwarfs all those preceding it. Many believe that the larger the credit easing excess, the worse the subsequent recession, but this is untested by any research we have conducted or come across yet.
World headed for cyclical slowdown
Despite the U.S leading economic indicators appearing healthy, the global economy appears to be headed for a slow down, with only 34% of the 40 countries we track having leading economic indicators (LEI’s) signalling growth ahead, and the actual GDP-weighted Global LEI growth now below zero:
The specific country details are displayed below:
The European countries, representing some 25% of world economic output have taken a decidedly worrisome turn :
Many of these LEI’s include sentiment data, and its probably a fair assumption to assume that the “trade wars” talk doing the rounds of late have a big part to play in these negative future growth projections.
Whilst the RecessionALERT U.S Leading index is currently looking robust, we cannot ignore the fact that there is a not-insignificant 40% correlation between the movements of the U.S LEI and the Global one. In fact a visual inspection shows that downturns in the Global LEI invariably always lead to downturns in the US LEI:
This correlation by no means implies a US recession, but it undoubtedly is likely to put downward pressure on the U.S LEI in the coming months.
It is early days for the co-incident data and no significant signs of a slowdown can yet be witnessed among them. To this end, here is an interesting chart of country GDP growth from 1Q2017 to 1Q2018:
If you are a RecessionALERT subscriber, you can view the comprehensive global report for May 2018 from the REPORTS menu. You can subscribe to RecessionALERT for a nominal fee over here.
Like this kind of information? We post occasionally to our public Twitter feed here : https://twitter.com/RecessionAlert2
Dealing with a runaway market
Those of you who have been following us since 2010 will identify us a perma-bulls. Even in the depths of the ECRI 2012 /Hussman recession calls we were firmly bullish on the US economy and stock market – quite contrary to the popular consensus at the time. Those subscribers who have been diligently following the RAVI SP500 forecasting model and its consistently accurate bullish forecasts will have noticed this year that all the targets we have set for 3Q2018 have been met on our Dashboard:
This means, for the first time since we have been running this model, that RAVI SP500 valuations have finally run ahead of themselves. This is not to say this exuberance will not continue for some time, but it is a warning for those who like to deploy valuation risk metrics in their asset allocation models.
Now for a long time, various valuation models have been at elevated levels. Here are a few below:
Despite these elevated levels, RAVI was forecasting bullish returns for 2016 and 2017. All these models above have very good correlations to 10-14 year ahead SP500 returns and in many instances of late were actually forecasting muted to negative 10-year ahead returns. But just because a valuation model is forecasting a negative 10-year return doesn’t mean that 1-3 year returns will be poor! This mistake is consistently made by forecasters! A case in point is shown below, using Warren Buffets famous valuation metric. Since 2014 this model has been persistently forecasting low to negative 10-year ahead returns – but that didn’t stop the SP500 roaring ahead!
Does this mean Warren Buffets indicator is useless? Of course not – it means it’s been interpreted incorrectly! In all likelihood, in 10 years’ time we come back to this chart and remark on how accurate it was since the black line (actual 10-yr returns) will closely track the green line (the forecasted 10-year returns.) As far as a long-run forecasting models go, the Buffet indicator, whilst not the best, is fairly respectable with an r-squared of 0.76 – so it would be surprising if that black line doesn’t hug the green line closely!
There is no model that can directly predict short-term SP500 returns with meaningful accuracy. But you can get pretty damn close (as these things go) by deriving short term returns from accurate long-run models like the Buffet model. It works like this:
1.Find a really robust and accurate long-run (assume 10 year) forecasting valuation model (there are many)
2.Get the 10-year forecast from this model from nine years ago
3. Work out how much the SP500 has grown since this date 9 years ago
4. Subtract (3) from (2) to work out how much upside is left in the year ahead.
In fact we can apply this short-run look-ahead method to any x-year horizon, and this is what we do with the RAVI to compute 1/3/5 year look-ahead forecasts:
The important thing to bear in mind is that the current reading of a long-term valuation model, be it Buffet, Tobin-Q, Shiller P/E, Hussmans Market-cap to Gross Value Add etc. means absolutely nothing to short-to-medium term forecasts. What is important, is what this model was saying 7-10 years ago and how much the SP500 has eaten into those forecasted gains since then.
Now the RAVI long-run model has the following 10-year forecasting profile, which at 0.89 r-squared is pretty respectable:
If we use the methodology described above to forecast 1-year ahead returns we get the following profile. I can tell you, an r-squared of 0.4 on such a short-run forecast is pretty decent as these things go. But quite obviously from the profile, you can see wide variances on occasion:
On a three year look-ahead things become rather respectable in terms of correlations for short run forecasts:
Five-year look-ahead accuracy is pretty remarkable given how close its correlation is to the accuracy of the 10-year forecast:
We can deduce that both the 5-year and the 3-year look-ahead models are forecasting around 4% annual growth for the SP500 from here on, which is pretty low. In fact it becomes pretty interesting to track the average annualized look-ahead forecast of all the models over time:
You can see that as the SP500 has been tracking upwards relentlessly, so the average annual forecasts have been declining of late. But more interesting is that when the average annual forecasts turn negative, it looks like, on the surface, we have a nice recession/bear market warning. Stock market valuation model as recessionary indicator – the idea is appealing!
So there you have it – we are in an era of weak forecasted SP500 returns with all the elevated risks associated with that. You need to decide if we are in a “new paradigm” of prolonged elevated valuations (its quite possible) and take your chances, or de-risk accordingly. Caveat Emptor
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Negative returns for SP500 in next decade
The RecessionALERT Valuation Index (RAVI) has been updated for 1Q17 and for the first time since 1999, is forecasting negative 10-year total returns for the SP500:
The chart on the right shows that the RAVI continues to forecast SP500 decade-ahead total returns with relative accuracy, especially when one considers that the green forecast line has data points that are seen 10 years before the black line depicting actual 10-year returns.
Now there have been a lot of valuation models predicting 10-year ahead negative returns but this does not mean one should be getting out the stock markets. One needs to review the short run (albeit less accurate) forecasts. As we can see below, these still hint at reasonable short run returns of the order of 11% per annum:
In March 2017, we used the 4Q16 RAVI forecast to predict returns for the SP500 to the end of 2017. Our low estimate was 2472, our median estimate was 2,565 and our high estimate was 2,718. As you can see from the RAVI daily tracker on top-right below, we have achieved the lower target and are 3.8% away from the median target and 10% away from the high target with some 5 months still to go:
Here is another interesting way to asses potential short-run returns for the SP500 – look at the US economy as per our Long Leading Index. When this signals recession then we have cause for concern for the stock market
25 most important US economic indicators animated in 1 minute
Here’s something fun we played with after just compiling our June Long leading US Index report for our subscribers
Horrific revisions to HWOL data
The Conference Board Help-Wanted-Online (HWOL) program is closely followed by us to get a feel for the labor market. It is one of over two dozen labor indicators we examine. The monthly HWOL data have been produced by the Conference Board since May 2005, replacing the Help Wanted Advertising Index of print ads, which was published from 1951 to 2008. HWOL data contain the universe count of all ads posted online during a month, with a mid-month survey reference period (e.g., data for October would be the sum of all posted ads from September 14th through October 13th). The HWOL program collects data from over 16,000 online job sources and removes duplicated ads.
The February release incorporated revisions with the following description “With the February 2017 press release, the HWOL program has incorporated its annual revision, which helps ensure the accuracy and consistency of the HWOL time series. This year’s annual revision includes updates to the job board coverage, a revision of the historical data from May 2005 forward, an update of the Metropolitan Statistical area definitions to 2015 Office of Management and Budget (OMB) county-based MSA definitions, and the annual update of the seasonal adjustment factors.”
“Great stuff” we thought. “Some solid revisions to keep us honest”. First up was “Total ads” which are all unduplicated ads appearing during the reference period. This includes ads from the previous months that have been reposted as well as new ads. We had to double-take when we looked at the data. It looked vastly different to the last time we peeked at it. Upon inspections the revisions were downright nasty:
We also look at the “New ads” which are all unduplicated ads which did not appear during the previous reference period. An online help wanted ad is counted as “New” only in the month it first appears. This is more volatile but provides useful comparison data to “Total Ads”. Again this is when that coffee you’re holding spills into your lap as you look in disbelief…ugly ugly ugly.
Both of these metrics are screaming recession from the hilltops – and this just after revisions. Given that the Conference Board is an organisation that’s being doing the data compilation and revisions thing for a while now, this has to be pause for thought. The labor market is not as well as we may think.
Let’s look at various labor indicators taken from our Long leading Index of US Economy:
So these HWOL revisions look rather alarming, but are not being collaborated by many other traditional metrics. Lets look at it again, but in the context of the last recession (grey shading). There’s no two ways about it – butt ugly.
The folks at The Conference Board are onto this though. From their website : “NOTE: Recently, the HWOL Data Series has experienced a declining trend in the number of online job ads that may not reflect broader trends in the U.S. labor market. Based on changes in how job postings appear online, The Conference Board is reviewing its HWOL methodology to ensure accuracy and alignment with market trends.”
The Board of Governers sniffed that something was up in June 2016 already, observing a substantial divergence since the end of 2012 between HWOL and the Job Openings and Labor Turnover Survey (JOLTS), administered by the Bureau of Labor Statistics. From their note : “All told, the average price for Craigslist job ads rose substantially, and roughly doubled since the end of 2012 (Figure 2), coinciding with the period when online vacancy posting as measured by HWOL noticeably underperformed the JOLTS vacancy growth.”
Now that the Conference Board is sanity-checking its HWOL methodology, it’s going to be really interesting to see how this pans out. But can this really be simply blamed on Craiglist prices? I’m not so sure. Surely its not that ridiculously simple?
Our house view is that we may have recently narrowly avoided recession, but are not close to it now. The lessons here are that reliance on single economic time-series, no matter how comprehensive they may appear (HWOL is fairly comprehensive in its number of datapoints), can be dangerous. It also highlights how revisions can wildly swing data with certain economic time series (as opposed to financial data such as interest rates, interest rate spreads, bond yields, credit spreads, corporate bond yields and the like.)
Mixed Signals from Labor Market
We keep getting good news about employment and the labor market. But we rarely see the less optimistic numbers.
Yellen’s Labor Dashboard (see here) is looking strong with all but 3 of the 9 components above pre-recession levels:
An index derived from the percentage of U.S states with rising unemployment looks worrying. Whilst the national unemployment figures seem fine, the population demographics of some large states seems to be masking underlying weakness at a state-level. Again, the broadness of this index makes for worrying numbers:
Here is another way of looking at the state-level unemployment numbers. The black line is derived from simply averaging up the unemployment rate from each individual state whilst the green line is the actual % of states with unemployment rates that are rising.
That means 75% of US States have unemployment levels higher than the best (lowest) numbers yet witnessed.
In summary, it would appear that several large-population states may be enjoying employment gains, but large swathes of the U.S are not.
NOTE : The state-level unemployment metrics shown above are excellent early-warning signals and are included in our highly comprehensive U.S Long-Leading Economic Index