RCM Managed Asset Portfolio - Q1 2022
RCM Managed Asset Portfolios
Most Signs Not Showing Recession
Christopher Chiu
Markets are developing quickly. Recently the 2 and 10 year US Treasury yield curve inverted, which is often taken as a sign of an eventual recession. A year ago, inflation began to develop as a source of major concern. And that concern has persisted. Amid all these different signs, let’s examine how close we are to a recession, using the same economic indicators we have used before.
Two years ago, we used unemployment claims as a way to gauge the likelihood of a recession. It was a good predictor then as we moved closer to recession in 2019. Recessions, remember, occur when the economy shrinks and is usually indicated by negative quarters of GDP growth. Back then I suggested that labor is the biggest input for determining recessions, that the other inputs--capital and technology--are fairly stable and constant in the US economy. But labor markets are cyclical and are affected by the money supply. When money supply shrinks fewer people and business spend and workers are less prone to be hired, more people file for unemployment. And with fewer workers, you get lower economic growth rates.
Looking at the labor supply now it appears that fewer people are available to the economy than there were even six months ago. With unemployment claims reaching historic lows, it appears businesses are struggling to find workers to further expand operations. Historically, when the number of continuing unemployment claims gets below 2 million it means there is not enough labor in the economy to continue the contribution to GDP growth. The economy will then eventually be vulnerable to some shock that sends it into a recession as shown by the grey areas.
This massive decrease in unemployment is not a great sign for investors because it means that this current economic cycle may be close to ending. One of the reasons the last economic expansion (2009-19) lasted so long was because unemployment took a long time to come down and this gave investors a long runway in which to invest. That is not the case this time as unemployment claims have come down sharply and continue to decline sharply.
On the bright side, the unemployment claims are not increasing which is what usually happens right before a recession hits. There is usually an upturn in claims before the recessionary periods. So while the conditions are ripening for a recession, it does not mean one is imminent.
There are other indications that a recession is not imminent, even as the economy has matured. Below is the industrial production index, which shows what has to occur for recessions to occur. The index has to be declining or at the very least going sideways for more than six months before a recession is to occur. That is not what is currently occurring. Industrial production is still on the rise.
Consistent with this picture (that a recession is not imminent) is the view offered by LEIs or leading economic indicators. LEIs continue to look strong. They consist of unemployment claims, manufacturers' new orders, building permits, stock prices, credit indices, interest rate spreads, and consumer expectations for the economy. So they offer a robust representation of what the economy will look like over the next six months. These LEIs would have to be rolling over as they did in 2000 and in 2006-07, or at least going sideways as they were in 2018-19 for a recession to occur and they are not doing that. As you see they are still on the rise.
Finally, I’m going to show you one my favorite charts that I use to track the state of economic cycles--heavy truck sales. I like looking at this chart often because it shows the practical capital investment decisions that business owners must make. If they feel that a recession is coming, they are unlikely to make large investments and have their equipment lay idle. And so heavy truck sales is one very good indication of forward business sentiment in the American economy.
What is the state of heavy truck sales? Currently they are still on the upswing. And at this point in the investment cycle, they have not reached the maximum number of trucks usually purchased at the peak of a cycle. Transportation companies that buy heavy trucks will eventually still find it worthwhile to continue to buy heavy trucks.
Historically the trucking industry maximizes the number of purchases at a level slightly above the previous peak. We have said in previous letters that the number of heavy truck sales must be above 500,000 and then come down again in a dramatic way before a recession hits. While sales did get above 500,000 in 2021 and then slowed down (probably because of a shortage of available trucks), they did not get significantly above 500,000 for an extended period of time. There are still not enough trucks on the road! So it would again appear that the US economy is still not quite at full capacity in this economic cycle. And as a rule of thumb in investing there must be a boom before there is a bust.
To be successful investing, you have to be tolerant of false signals because there are many of them. And if you act on every sign of menace you are not going to be participating in the market when things turn positively. While the market may hit the doldrums every once in awhile in every investing cycle, it does not necessarily mean the investing cycle is coming to the end. False signals may occur here and there and give rise to nervousness. But it is only when many signs are showing the same thing that we think it is the time to act. We do not yet appear to be at that point.
