If a Recession is Coming: An Update

In a recent post we introduced the Recession Risk Dashboard, a very interesting resource developed by Jeff Schulze and his team at ClearBridge Investments as part of a larger project called “Anatomy of A Recession.” The Dashboard updates 12 recession-leading criteria or indicators their research has identified as helpful in evaluating whether the economy is expanding (green), mixed/caution (yellow) or contracting/recessionary (red). As we reported in that post, as of 6/30/2019 the overall reading moved from expanding to caution.

In a recent update, two indicators turned red and one turned green leaving the overall reading as “Caution” with 6 green, 3 yellow and 3 red as of 8/31/2019 which, coincidently, is the same count distribution the dashboard had at 2Q 2006. (Individual criterion rankings at 8/31/2019 and 6/30/2006 are different).

In an effort to add some additional substance to this update we quote from ClearBridge’s Recession Indicators Update of September 5th [1]:

"ISM Manufacturing New Orders Turns Red

The…Purchasing Manager Index (PMI) is…synonymous with the business cycle, foreshadowing periods of increasing and decreasing economic activity. The headline figure fell to 49.1 in August, below the breakeven 50 level, signifying that the domestic manufacturing sector contracted for the first time in four years…the New Orders subcomponent…tends to lead [the PMI] by several months [and] typically…fall below 48 in advance of a recession. This measure fell to 47.2 in August, tied for the weakest reading since the global financial crisis (Exhibit 1) and turning the indicator to red from yellow."

Source: Bloomberg, as of 8/30/19. 

Past performance is no guarantee of future results.

Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Corporate Profit Margins Turn Yellow

…margins for large- and mega-cap companies are holding up fairly well, margins for small- and mid-size businesses are coming under increased pressure…the cost of labor continues to be a major headwind for these smaller companies [which represent employers of 77% of Americans]. [2]

As a result of this dynamic, the National Income and Products Accounts (NIPA) profit margins (which the dashboard evaluates) are a much better barometer for the economy…As Main Street businesses are forced to cut back on spending to preserve margins, their suppliers may also be forced to curtail activity. Typically, firms reduce hours first before laying off workers due to the significant costs associated with hiring and firing…weekly hours worked by the average manufacturing sector employee have fallen by 0.7 hours over the past year, and overtime has been cut by 0.5 hours while margins could also face pressure from increasing tariffs.

Exhibit 2: NIPA Profit Margins Could Come Under More Pressure

Source: Bloomberg, as of 8/30/19. 

Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

On the positive side “…the Conference Board consumer confidence data looks much healthier. Specifically, “jobs hard to get” responses have fallen back to cycle lows, while “jobs plentiful” responses saw their second-largest increase on record…” which turned the Job Sentiment indicator positive.

So, as of 8/31, here’s how the ClearBridge Recession Risk Dashboard looks:

Source: ClearBridge Investments, as of 8/31/19.

[1] Schulze, Jeff & Josh Jammer, Signals Change, Caution Remains, ClearBridge Investments Recession Indicators Update, September 5, 2019. Emphases added are indicated by bold italics.

[2] “…77% of Americans are employed by firms with fewer than 500 workers. For reference, the average company in the Russell 2000 Index has 3,679 employees. Not surprisingly, it is Main Street that drives the U.S. economy.” Schulze p.2.

Ed Lynch is founder and CEO of FPG. He has worked with ERISA-qualified plan sponsors and designated fiduciaries in most aspects of plan development and maintenance since the early 1980s. Ed founded FPG with the mission to be a leader in the field of employee benefits and the most trusted source of information and evaluation in the retirement plan industry.