Economists Have Predicted Nine out of the Last Five Recessions

If you think that this has been a bad start to the year for stocks, you are
absolutely right! It has been the worst first half of the year since 1970. The
biggest stock market declines typically happen in the latter half of the year
during September and October. I believe that sharply higher commodity prices
resulting from the Russian invasion of the Ukraine are largely responsible for
creating this decline in the first half of the year instead of later on. Since 1950,
90% of the gains in stocks have occurred from November 1st to May 1st. Major US
stock market averages performed well from November 1, 2021 until January
2022, before prices began to falter. The S&P 500 is now in the range of where it
was two months ago after falling more than 20% from the all-time high on
January 4, 2022. It continues to bounce along the bottom. The low point for this
bear market occurred on June 17th. (The chart below is from WSJ).

I have found that human behaviour is very similar during market sell-offs and
bear markets. Therefore, I focus on how investors are reacting in the market place
to see when the selling reaches the extreme levels it has reached during previous
serious declines. So many of the indicators I rely on to measure the level of
pessimism and selling have recently reached the extremes that have occurred at
market bottoms in the past. Therefore, it seems like the risk of further downside is
low.

Stock prices have recovered somewhat from the lows on June 17th. As of
today, the S&P 500 has been up four days in a row for the first time this year. At
extremes like this, there is not much else one can do other than wait for a catalyst
to occur that gives a sudden boost to investor confidence so that they see the glass
as half full instead of half empty. As I have stated before, the most common
catalyst has been a positive comment about the direction of interest rates by the
U.S. Federal Reserve Board, or an actual reduction in interest rates. I cannot see
that happening anytime soon.

However, the prices for commodities such as oil, copper and wheat have
already dropped considerably from the highs in April. If these prices stay where
they are now until March 2023, or move even lower, the rate of inflation could
fall sharply early next year. There could even be deflation.

Oil prices fell below $100 for the first time in months yesterday after peaking
at $130 a barrel on March 7th. Lower commodity prices help to reduce inflation,
which means that interest rates may not have to rise as much as the Fed and
investors are expecting. Therefore, further declines in commodity prices may be
the catalyst at a time like this. Only time will tell. Patience is required in the
meantime.

It is interesting how the issues investors seem to be concerned about are
constantly shifting. First it was the pandemic in 2020 and economic shutdown.
Then it was variants of Covid 19. After vaccines became available, supply chain
issues and rising costs became the main concern. Then inflation and the likelihood
of rising interest rates was top of mind. When Russia invaded the Ukraine, it was
like a perfect storm for rising inflation. Most recently, rising interest rates have
increased fears of an economic recession. If it isn’t one thing, it is another. This is
the way it has always been and will likely continue to be in the future. There will
always be something to worry about that makes it seem like stocks are not a good
investment.

So, are the US and Canadian economies going to fall into a recession sometime
soon? In 1996, Federal Reserve Board economists Arturo Estrella and Frederic S.
Mishkin published a report in Current Issues in Economics and Finance, entitled,
“The Yield Curve as a Predictor of U.S. Recessions.” Out of 26 indicators that
were examined, they discovered that the basic yield curve was the best indicator
to use for predicting a recession. They wrote, “The yield curve – specifically the
spread between interest rates on the ten-year Treasury note and the three-month
Treasury Bill – is a valuable forecasting tool. It is simple to use and it
significantly outperforms other financial and macroeconomic indicators in
predicting recessions two to six quarters ahead.” So, there you have it. We can
look at all sorts of other indicators as well but will that make us more reliable or
less reliable? I choose to accept the findings of their research, which is entirely
based on statistics, not opinions. If this yield curve is the most valuable
forecasting tool, what is it showing us today?

This chart shows that the yield curve of the 3-month T Bill and 10-year
Treasury note inverted in the fall of 2019. Sure enough, North American
economies briefly fell into a recession in early 2020 when the coronavirus swept
over the world. The yield curve inverted or went below 0 in early 2020 as well. If
you look at the line on the far right you can see that the spread was higher than
2% earlier this year and it has recently dropped sharply to the 1% range. The yield
on the 10-year Treasury note is 1.06% higher than the yield on the 3-month T Bill
today. The spread is far from dropping to 0 or below at this point. Therefore, this
indicator is not close to forecasting a recession at this time.

While this yield curve is not even close to inverting, the yield curve on the 2-
year bond and 10-year bond has just barely inverted.

The yield on the 2-year Treasury note is now 0.02% higher than the yield on
the 10-year note so it is very slightly inverted.

This variation of the yield curve above is causing many to call for a recession.
I have found that the media is not really interested in providing us with useful,
accurate information. The main goal of the media seems to be to attract attention
or “eyeballs.” Proclaiming forecasts of a recession does attract at lot of attention
for business owners since poor economic times can be devastating for a business.
Many workers can also lose their jobs in a recession, so forecasts of a recession is
important news for every worker as well.

Even though the research by Estrella and Mishkin was done in 1996, I have
found the results to be accurate since that time. Consequently, I have found that
looking only at the 2-year and 10-year spread is not that useful. We must also
look at the 3-month and 10 year spread. Both of these yield curves should invert
if there is likely to be a recession in the next 6 to 18 months. As you can see in
the previous page, the 3-month and 10-year yield curve is clearly not
inverted at this time. This all suggests that experts should not be warning
investors and the public that a recession is likely.

There have been many false warnings about future recessions, which gave rise
to the saying, “Economists have predicted nine out of the last five recessions.”
Unless the yield curve inverts for the 3-month T Bill and 10-year Treasury note,
all the recession forecasts we are hearing are likely to be another instance of false
warnings. Please see Chapter 15, A Point Of Interest, in our book, Mind, Money &
Markets for more information about this topic.

(In last week’s Update I wrote that Donald Trump was the Democratic Party
candidate. That was an obvious error on my part and I apologize for the mistake!
My mind sometimes does strange things after writing and focusing on what I want
to communicate for hours at a time ☺)

 

SAR Update

In the first half of 2022 our team has had 28 calls compared to 48 calls last
year. The damp, cold weather so far this year is likely the reason for the lower call
volume. We had a call to attend an ATV accident last week, just as the long
weekend was getting started.

Whenever possible, the air ambulance is called out of the Vancouver airport
when there are reports of a head injury. It may also be called if there are reports of
other serious injuries. I assisted with the landing zone for the air ambulance
instead of going to scene of the accident. We had another incident on the Fraser
River on Saturday.

Last July 1st it was blistering hot. It poured rain on July 1st 2020, but those days
did not matter much since there were no public activities. It was very nice to have
a perfect day on July 1st this year so we could finally enjoy some public fireworks
again in the beautiful setting of Harrison Lake with the noise echoing against the
mountains. It is so nice to be very close to normal again!

Be safe out there and have a wonderful weekend my friend!

 

Why do you have to be careful what you say around egg whites? Because they
can’t take a yolk.