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When Leading Could Be Lagging

For most of us in the investment world, we have relied on tried-and-true economic indicators/signals that have generally been foolproof in helping us get a sense of where we are in the economic cycle. More so today there has been a reliance on these signals given the big moves in inflation and the resulting dramatic action by the FED. We can argue the causes and the path that has gotten us to this point, the pandemic and resulting extreme global uncertainty, and the critical risk management decisions. But there is no dispute the extraordinary fiscal and monetary policy actions taken were unprecedented and we might even characterize that “caution was thrown to the wind” and that it was acceptable to take on lesser and manageable outcomes rather than the complete meltdown that “could have been.”


This most probable outcome would be inflation and then the predictable outcomes after that. Can you say recession? This is where we get into two very recognizable indicators that “experts” follow to not only forecast future economic activity but also use to manage asset allocations between bonds, stocks, and other asset classes.


The first is to monitor the slope of the yield curve and particularly when it’s inverted and the depth of that inversion. In “normal” times, the yield curve should slope up and to the right, reflecting a healthy economy and investors who have a positive outlook on risk and return. Inverted yield curves have generally forecast recessions. So much so that, the NY FED looks at the three month/10 year bond spread as a forecasting tool to predict an upcoming recession.



Here is the current signal, and the fact is that it has been and continues to flash recession. However, this time, inflation did go higher and has come down since early 2023, but unemployment has not risen like history would predict. One might characterize that unemployment has been relatively unaffected. Taking unemployment out of the equation, we have had an amazing policy success, starting with a fiscal response to the crisis and now a monetary response to that fiscal response. In fact, at the expense of the “recession predicting tool” if we escape with a soft landing or no landing, we might even believe that the FED and its instruments worked. Of course, there are always those that will complain about whether the FED action was too late, too much, too long, not enough, but time and time again, perfection is the enemy of good. At this point, we are staring “good” in the face despite what the 10 yr bond/ 3month spread may indicate. Even now we see the 10yr bond rate rising which should bring the above chart out of recessionary territory.


Let’s now look at the second indicator, known as the Conference Board’s Leading Economic Indicators, the LEI. The LEI is designed to predict the future of the economy.



The 10 inputs comprise of 3 financial components and 7 nonfinancial components, and the LEI has been used to predict in advance a potential recession. See chart. Most recently, the LEI has continued to decline by another 4.3% over the last 6 months and has declined consecutively monthly for over a year. Again, with unemployment still quite low, inflation abating, and consumer spending relatively stout, and markets rebounding, it seems that this signal is lagging. There is as much evidence that in the short run a recession seems unlikely if not a soft landing being highly likely.



On one hand, policy levers—both fiscal and monetary—seemed to have worked quite well while two stalwarts of economic forecasting are in contradictory positions. One thing is for sure, patient investors not obsessed with recessions should view them as insignificant speed bumps. Crestmont Research recently affirmed a study that others have done before but in essence since 1919, investing in something like the S&P 500, there have been 104 twenty year rolling periods and it turns out that all 104 year periods had a positive return. Only a hand full of those periods delivered an annualized return less than 5% and more than 50% delivered and average rate of return of more than 9%. Imagine too, that every year one is making new investments of new money and you can see that long term investors make money. If you are able to overcome your risk aversion, there was also, since 1950, 39 double digit downturns which make declines “common” but potentially exploitable, but we’ll leave that for another day.

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