2 Recession Indicators Warn of Danger Amid Bull Rally

Economic recessions, or expectations of them, normally send stock prices downwards. Meanwhile, strategists at Paris-based investment banking firm Societe Generale Group warn that two indicators with excellent predictive histories are pointing to an economic downturn. These are the yield curve and SocGen's proprietary newsflow measure.

"In our view, profit warnings, defaults and increased volatility are likely to be the dominant themes in the next 12 months," SocGen strategist Arthur van Slooten said in a note to clients, as quoted by Business Insider. "Maybe 2019 is the year that we should wake up to the possibility that the next recession could be closer than initially thought," he added.

3 Most Recent U.S. Recessions

• Dec. 2007 to June 2009: 18 months
• March 2001 to Nov. 2001: 8 months
• July 1990 to March 1991: 8 months

Source: National Bureau of Economic Research (NBER)

Significance For Investors

The simplified version of the yield curve used by SocGen charts the difference between the rates on 2-Year and 10-Year U.S. Treasury Notes. Long term interest rates normally exceed short term rates, and an inverted yield curve, in which short term rates are higher than long term rates, has preceded every U.S. recession since the 1960s, BI notes. SocGen observes that the spread between the 2-Year and 10-Year T-Note yields is the smallest since the 2008 financial crisis.

SocGen's newsflow indicator summarizes news reports about the economy into positive and negative stories. As negative stories become a larger percentage of the total, this indicator becomes increasingly bearish. The Investopedia Anxiety Index (IAI), which deduces our own readers' sentiments about the markets and the economy based on their reading patterns, is a similar concept.

A deceleration in global industrial production, partly the result of the continuing trade conflict between the U.S. and China, is sending the SocGen newsflow indicator in a bearish direction. Since the late 1990s, pessimistic coverage of the global economy has tended to follow trends in production, and the newsflow indicator has pointed down ahead of most economic contractions in this period.

Just looking at the U.S., the newsflow indicator is anticipating a downturn in the ISM Purchasing Managers' Index. In fact, the U.S. Economic Newsflow Indicator (US ECNI) is now delivering a reading that is among the lowest 7% recorded since 1998.

Nobel Laureate economist Paul Krugman warns that U.S. economy may be headed for a recession. "The underlying backdrop is that we have no good policy response" from the Federal Reserve, he said, per Bloomberg. "Continuing to raise rates was really looking like a bad idea," he added.

Economist Noriel Roubini, writing in Barron's, says that "the risk of an outright global recession is low." However, he continues, "we heading into a year of synchronized global deceleration." Among his concerns are economic slowdowns in China and Europe, the protracted U.S.-China trade war, Brexit, "America's dysfunctional domestic politics," overvalued U.S. stocks, rising U.S. wage costs, U.S. corporate debt, and an oil supply gut that may cause defaults in the energy and related sectors.

Investment manager David Tice says that the probability of a U.S. recession in 2019 is 50%, and expects stocks to decline by as much as 30%, per CNBC. However, he has been predicting significant stock market plunges since at least 2012, per earlier reports. A global economic slowdown and "massive" corporate and government debt loads are among his biggest worries.

Looking Ahead

With the dovish turn by the Fed may have bought some time for the U.S. and world economies, the odds of a significant economic downturn appear to be rising.