There's a decent amount of evidence coming in to suggest a recession could have arrived early:
1) The S&P global PMI showed rapid deterioration in manufacturing, business activity, and composite indices. The chart looks very pre-recessionary.
...business activity fell at the joint-sharpest rate since May 2020.
https://www.pmi.spglobal.com/Public/Home/PressRelease/2449edd6ab0a49b9bd0103ecc24a28b3"Business conditions are worsening as 2022 draws to a close, with a steep fall in the PMI indicative of GDP contracting in the fourth quarter at an annualized rate of around 1.5%," said Chris Williamson, chief business economist at S&P Global Market Intelligence.
https://finance.yahoo.com/news/stock-market-live-news-updates-december-16-125058708.html2) Inflation is falling, despite relatively low interest rates 2-3% below CPI and deep in stimulative territory. Maybe it's not that the Fed is beating inflation, it's that inflation is doing what it typically does as we head into recession. Asking how inflation is falling when policy is still stimulative might be missing the point if inflation is falling due to recession.
https://fred.stlouisfed.org/series/CPIAUCSL#03) Retail sales seem to be going DOWN into the Christmas season(!) contrary to my earlier expectations. Also, retail employment seems to be falling.
https://fred.stlouisfed.org/series/RSXFShttps://fred.stlouisfed.org/series/USTRADE4) Long-term yields are falling, as investors pile into duration. The thinking here is that demand for safe-haven treasuries is about to go up and interest rates are about to go down. The 10y treasury yield has fallen from 4.22% on 11/7 to 3.44% yesterday. TLT has gained 13%. ZROZ is up about 24% from its lows. More gains could be coming for high-duration bonds.
https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2022
5) The last time the
10y/2y yield curve inverted by -0.79% or more on a falling trend, like it is now, was May 1981 (at -0.9%). A severe 16-month recession started 2 months later in July 1981 that led to a 3.1% overall increase in unemployment.
https://fred.stlouisfed.org/series/T10Y2Y6) The current 2.3% personal savings rate has only been lower one month in the recorded history of that metric: July 2005. We have to be at a natural limit for this number, and people are going to have to cut back their spending soon. To think about this in terms of averages, how many people in your neighborhood must have a negative savings rate to make up for one mustachian and pull the average down to 2.3%???
https://fred.stlouisfed.org/series/PSAVERT7) Natural gas prices are doing what they did in 2000 and 2008, though they gave a couple of false signals between those years. I think a spike and collapse in the NG price means something when it co-occurs with some of the other recessionary metrics. UNG is not a bad candidate for bear spreads if you think a recession is on the way. I'm looking at doing a way-OTM bear spread with 399 days to expiration that would probably yield 32%.
https://tradingeconomics.com/commodity/natural-gas
8) The housing industry is in recession. Single-family home starts are falling like they've rarely ever done except when there has been an imminent recession in the broader economy.
https://fred.stlouisfed.org/series/HOUST1F----------
On the other hand, there are several reasons to think the recession isn't here yet.
Initial claims are still low. It's not a recession if people aren't losing their jobs!!!
https://fred.stlouisfed.org/series/ICSAThis may be related to the backlog of open jobs Jerome Powell has been talking about. Many of those who are geting laid off hop into another job before they can even bother to file a UI claim. But of course this also sends a false signal to the Fed about the effect of their policy on unemployment, because maybe jobs are evaporating and claims will skyrocket once that slack runs out.
The Fed's GDPNow bot estimates GDP growth of about 2.8%, although this estimate is falling.
https://www.atlantafed.org/cqer/research/gdpnowThe NFCI says financial conditions have been loosening for the past several weeks, and firms have better access to capital than they did in October when the NFCI peaked at -0.029. The NFCI is a great recession predictor, but we should keep in mind it peaked at -0.024 in 2000, and never broke through the zero barrier just before that recession. Also, the NFCI spent much of the mid-late 1980s spewing false recession predictions amid the S&L scandal.
https://fred.stlouisfed.org/series/NFCI--------------------
Here's what happens next: The yield curves will rapidly un-invert right before or as we enter recession. Aside from the early 1980s, this has occurred at the start of modern recessions because short-duration rates fell faster than long-duration rates.
Unfortunately, this outcome is a lot less clear as an investment theme than 2022's simple bet that rates will go higher. Short-duration yields are harder to wager on, outside of futures markets. You could go long TLT or ZROZ instead of short.
However it's not clear to me whether other investors will continue to expect rate cuts if inflation remains in the 4-7% range during the recession. Then,
even if for example the FFR was dramatically cut to 3%, it's not clear whether 10-year yields would go up or down from the current 3.44%. Either way - up or down - we'd end up with an un-inverted yield curve.
If the recession is coming sooner rather than later, as the reasons above suggest, then we could go through a long period of recession before the Fed worked up the confidence to cut rates for the first time. In the event of a 1Q2023 recession start date, we might have rate hikes continuing until March 2023, and a first rate cut in 1Q2024, contingent upon inflation being below the FFR. Such a timeline would be consistent with the Powell Fed's historical lags in action.
In contrast, if the recession comes later rather than sooner, then the Fed will have reached peak rates, we will have seen inflation fall a long way before the recession hits, and the Fed will be able to be more active.
What happens after the recession: In 1992, 2003, and 2009, the post-recession 10y/2y yield curve bounced from negative to above +2.5%. For that to happen again, and for the longstanding pattern of long-duration yields falling less than short-duration yields to continue this time, then short-duration yields might need to fall to near zero again. I.e. today's 3.44% ten year yield minus 2.5% would predict a 2-year yield of <1%, and that's before we account for the longer-duration yield falling as it usually does in a recession. The TIPS/treasuries market is predicting a future where a near-zero FFR makes sense. The 5-year inflation breakeven is 2.21% and falling!
https://fred.stlouisfed.org/series/T5YIE The bond market is really thinking this is 2008. The stock market remains hopeful, judging by the S&P500 having a PE ratio 25% above the long-term mean, despite plentiful recession warnings.
I'm mostly positioned in a bunch of 6-month treasuries, in addition to some of the long-duration corporate bonds I picked up near the bottom in November, and some SPDN. My goal at this point is to shift into growth stocks, financials, and/or preferreds maybe 3 quarters into the recession. By that time, recession will be obvious in the data and it'll be a buyer's market.
I regret that I didn't load up on more long-duration corporate bonds in late October and early November rather than committing to DCAing into them. The bonds I did buy are up 7%-17% I was hoping the yields would return, but given the recent CPI and economic data I suspect we may have seen the peak for long-duration yield.
