Acute threat: a looming U.S. recession

  • The threat of a U.S. recession will add to a number of looming issues contributing to heightened financial market and economic complexities and uncertainties in 2020.

  • While some of the latest economic data suggest that growth in the U.S. economy remains steady, some key market and economic indicators are more consistent with a downturn, like the inverted yield curve.

  • The health of the U.S. consumer is likely to hold the key to the health of the U.S. economy and the potential timing of a U.S. recession.

In addition to the financial market distortions, debt overhangs and democratic challenges to getting ahead financially over the long term, lies the increasingly real potential for a U.S. recession in the near term.  The reason an economic downturn is important is because of its immediate and acute effects on households, particularly as it relates to its potential to derail life transitions as emergency savings are put to the test, opportunities to get ahead are stalled by lending and labor market tightness and financial market volatility further complicate aforementioned retirement insecurity. 

The making of an economic downturn

What is a recession? On the one hand, a commonly cited definition of a recession is two consecutive quarterly declines in GDP growth.  The National Bureau of Economic Research, a highly regarded business cycle dating group, on the other hand, broadly defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales”. 

Put in simpler terms, a recession is a crisis of confidence experienced by businesses and consumers that is preceded by a set of events or circumstances (inflation shock, financial market disruption, war, social unrest) leading to a broad slowdown in economic activity.  More than ten years have passed since the U.S. experienced its last recession and comes at a time when downturns tend to happen once every 5-7 years[1].  Does this mean that a recession is imminent?

[1] National Bureau of Economic Research, Business Cycle Dating, December 2019

Figure 1: Yield curve inversions lead recessions by 18-24 months

Source: Franklin Madison Advisors, Federal Reserve, National Bureau of Economic Research; 12/10/19. Note: Line represents the difference between 10-year and 3-month U.S. Treasuries. A value below zero represents inversion.

What the recession indicators are saying

While some of the latest economic data suggest that growth in the U.S. economy remains steady, some key market and economic indicators are more consistent with a downturn, like the inverted yield curve.  More specifically, the spread, or difference between the yield on 10-year and 3-month U.S. Treasurys is historically consistent with a recession beginning 18 to 24 months after the spread turns negative. 

Using history as our guide, an inversion of the yield curve in 2019 suggests that the risk of a recession is likely to increase in mid-to-late 2020.  Nevertheless, no one measure can accurately predict a downturn in the economy and so it is important to look to other economic indicators for more confirmation of a likely downturn.

Figure 2: U.S. business confidence in decline on trade uncertainties

Source: Franklin Madison Advisors, Organization for Economic Cooperation, National Bureau of Economic Research; 12/10/19

To be sure, measures of business and household sentiment are another statistically significant indicator of a potential recession.  And lately, business confidence in the U.S. and globally has weakened from its peak in 2018.  This comes as the positive effects of the U.S. Tax Cuts and Jobs Act have faded, and the U.S. has raised tariffs on important economic and trading partners like Canada, Mexico, China and Europe. 

At the same time, China’s credit-fueled growth continues to slow, putting downward pressure on economic activity at home and among its important trading partners, including the U.S.  Taken together, these and other financial market complexities and geopolitical uncertainties are contributing to a greater level of caution among business leaders. 

This is important because as businesses lose confidence, they tend to cut back on discretionary spending activity like replacing aging equipment, expanding facilities or adding new jobs.  At the same time, businesses tend to pare back on the amount of inventory held in storerooms, putting downward pressure on factory orders and manufacturing activity.  Indeed, recent surveys of corporate executives suggest plans to curb capital expenditure and hiring activity in the coming year as corporate earnings growth are expected to slow.[2]

[2] Duke Fuqua School of Business, “Duke CFO Global Business Outlook”, September 2019

Figure 3: Economic growth forecasts downwardly revised

Source: Franklin Madison Advisors, International Monetary Fund; 12/10/19

A slowdown is coming, consumers may hold the key

Recession or not, economists have ratcheted down their expectations of global growth and largely expect economic activity to weaken in 2020.  Most notably, the International Monetary Fund in October 2019 published revisions to its World Economic Outlook that suggest global GDP growth will slow to levels not seen since the 2008-2009 global financial crisis.  And while slower economic growth does not necessarily portend a recession, it does increase an economy’s susceptibility to a downturn, particularly at a time when a few recession indicators are flashing amber. 

One factor underpinning positive economic growth and arguably staving off an economic downturn has been the resilience of household spending.  U.S. retail spending growth has largely surprised to the upside in 2019.  And this followed a rebound in global equity markets and the prospect of falling interest rates earlier in the year, which likely buoyed household sentiment and underpinned household consumption in major economies.  A key question today, however, is whether this virtuous trend in spending can continue amidst a host of uncertainties, particularly as elections and trade uncertainties loom in 2020. 

Moreover, the buoyancy of consumer sentiment is likely to remain tied to developments in the business sector.  As business uncertainties grow, employers are likely to further curb hiring activity.  This means that the current slowing pace of job gains is likely to be exacerbated by falling sentiment, making it harder for some people to find work and leaving others worried about their own job prospects and potentially feeding into a cycle of falling discretionary spending and hiring activity. 

Either way, with government spending constrained and business spending expected to slow, a decline in household spending could tip the U.S. economy into a recession, leading to a period of heightened economic and financial market volatility and challenging households’ ability to get ahead financially. 

In our final post in this series, we discuss how households can get ahead, financially, despite growing financial market and economic complexities and uncertainties. 

This post is an excerpt from our report, Getting Ahead Financially in 2020.  You can download this report in its entirety by visiting franklinmadisonadvisors.com.

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About the Author

Peter Donisanu
Peter Donisanu is Chief Financial Strategist and President at Franklin Madison Advisors, Inc. Franklin Madison Advisors is a fee-only fiduciary financial planning and investment management firm based out of Pittsburgh, Pennsylvania and serving clients nationally. We exist to serve a generation that has been underwhelmed by traditional paths to financial security and independence.