Sep 22, 2016 | Post by: Roman Chuyan, CFA Comments Off on U.S. Recession Might Begin Within 2 Quarters

U.S. Recession Might Begin Within 2 Quarters

U.S. economic fundamentals have deteriorated markedly since last year, now to an extent that a recession may be on the horizon.

Recession dates are declared with a lag of six months or longer – we know that the economy is in a recession at least six months after it has begun. Recognizing a recession in a timely manner is extremely important for business and investment decisions, but has always been a challenge for economists.

At Model Capital, we have developed a simple recession indicator consisting of two economic series: YoY % change in Manufacturing, and monthly change in the Fed’s Labor Market Conditions (see chart). This “MCM Recession Indicator” gives a recession warning when both series turn negative.

recession indicator for tactical investment management

The indicator’s historical record is pretty impressive. In 40 years of available data, the indicator was triggered eight times, shown by the arrows. Two of the eight instances occurred 5-6 months into a recession (in 1981 and 1990), four times a recession followed within 7 months, and twice the indicator wasn’t effective (in Jul-1989 in 2002).

The indicator was just triggered again, after August manufacturing declined by 0.24% from last year. Again, when this happened in the past during expansions, a recession followed within 7 months with 2/3 (or 66%) frequency.

I should add the following caveats to this prediction. The small August decline in manufacturing might be revised next month. Eight observations are not really enough to be statistically significant. Although some data did weaken recently, such as the unexpected decline in both manufacturing and non-manufacturing ISM surveys, broader economic data need to also weaken for a recession to be imminent. We will have more clarity next month – please stay tuned.

Model Capital Management LLC is a tactical investment manager. For details about Model Capital’s fundamental, forward-looking approach to tactical investment management, visit here; review the list of our tactical management strategies here. Please contact us for information on how we work with advisors.

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