Inflation & Recession - Charts
In this blog post I just wanted to pull together some charts that may be useful as indicators on where we are currently and expected to go in relation to inflation and the recession.
I have to admit, I am a bit of a chart man and like to look at indicators. Whether useful or not, I like to be able to look at the macro economics when assessing risk in my portfolio.
Although I am a UK investor, I mainly follow the US markets / indicators. Main reason being that the US economy is the largest and therefore other global economies often have to deal with the fall-out from the US. So the charts I will present below are US focussed charts.
P.S. apologies to those who follow my blog that think this is “information overload”. Let me know in the comments if this is something you liked reading. I promise I will post more interesting stuff if this isn’t your thing!
Inflation
Let’s start with inflation. As I write this post, inflation in the US stands at 7.1% having peaked at 9.1% in June 2022.
Oil Price
Oil prices have been dropping of late with the spot price of Crude (WTI) oil dropping from approx. $115 a barrel in June 2022 to approx. $73 a barrel in today.
Oil prices have a major impact on inflation so you could expect that if oil prices continue to decrease that inflation will follow. Spikes in oil prices have also often preceded recessions as you can see in the chart below.
Copper Price
Similarly to oil, Copper has been dropping in price from approx. $10,200 a metric ton to approx. $8,400 a metric ton today.
Copper prices have been a good leading indicator because of Copper’s widespread application. Therefore, the demand (or price) for Copper is a good indicator for the health of the economy. If orders for Copper are dropping (and price declining), then this would be an indicator for a recession.
US ISM Manufacturing Prices Paid
In the last year, the US ISM Manufacturing Prices Paid index has dropped from a peak of 87.1 to 39.4.
The ISM manufacturing index or purchasing managers’ index is considered a key indicator for the US economy. It indicates the level or demand for products by measuring the amount of ordering activity.
A value above 50 indicates an expansion and a value below 50 indicates a contraction of the manufacturing segment of the economy.
Contraction of the ISM index can be a leading indicator for a recession or slow down in the economy.
Unemployment Rate
The US Unemployment Rate has not yet started to crack but could this just be a delay in the publication of the data? We have seen recently that there has been significant lay-offs in the Technology sector - will the rest of the economy follow?
Rises in the unemployment rate have often been linked to recessions as you can see from the graph below. However, they are not always a leading indicator. By the time people lose their job, the damage has often already been done.
UoM: Consumer Sentiment Index
The University of Michigan Consumer Sentiment index has plummeted to the lowest levels we have seen since the 1980’s.
Similarly to the unemployment rate, low levels of consumer sentiment have often coincided with recessions.
10-Year Minus 2-Year Yield Curve
The 10-Year Minus 2-Year Yield Curve has inverted to the lowest levels we have seen since the 1980’s.
The inversion of the yield curve, particularly the 10-year minus the 2-year yield curve, has been a strong leading indicator for a recession as you can see from the chart below.
George Soros also wrote in his trading notes in the Alchemy of Finance that the best time to buy bonds is when the yield curve is inverted as the future expected returns are very high.
An inverted yield curve signals economic weakness. This also means that future rate cuts are likely on the horizon to stimulate the economy.
Federal Funds Effective Rate
The Federal Reserve has increased interest rates significantly but the Federal Funds Effective Rate is now approximately at the same level as the 2-Year Treasury Yield. Normally, once at these levels, the Federal Reserve will stop hiking and pause - they will also likely begin to consider cutting rates. This may sound positive but this indicates that the economy is likely to be entering a recession (or at least the Federal Reserve would be starting to acknowledge that).
Federal Reserve Total Assets
The Federal Reserve has continued to employ Quantitative Tightening - going from approx. $9 trillion in March 2023 to approx. $8.5 trillion in Total Assets today.
Quantitative tightening cycles have often coincided with weakness in the economy and declines in the stock market - similar to what we have seen over the last year or so.
Conversely, quantitative easing cycles have often coincided with stimulation of the economy and increases in the stock market. Once the Federal Reserve starts to apply quantitative easing, the stock market is likely to begin recovering. For now, the tightening continues.
Volatility Index
The Volatility Index has not really broken out of a range it has been in for the last year or so. Is it beginning to coil up or will it start to reduce in 2023?
Spikes in the volatility index often coincide with declines in the stock market. Large spikes particularly coincide with sharp sell offs like we saw in 2020.
The volatility index can also be thought of as the “fear index” as it essentially measures the amount of panic in the market.
High Yield Bond Spread
The High Yield Bond Spread did increase in 2022 but is now starting to decline / consolidate. Will we see an increase in 2023?
This spread gives the percentage difference between high yield bonds and the Treasury bond yield. High yield bonds offer higher interest rates due to the increased default risk an investor takes. The higher the risk, the higher the interest rate that is likely to be paid.
The spread between high yield bonds and Treasury bonds are an indicator for assessing the health of credit markets and economy. If the spread is increasing, this can signal weakening macroeconomic conditions.
Summary
I have presented a number of indicators that paint a picture regarding the health of the economy / inflation and the direction of travel. Based on these indicators, it would appear that the weaker economic conditions may be ahead and that inflation is likely to drop.
In terms of investment assets, you could expect that risk assets (such as equities) may be at risk. Government bonds tend to do well in periods of economic uncertainty and weaker economic growth. I will leave it with you to decide what to take from all of this - I just thought it was a useful set of charts to provide a macroeconomic picture for consideration.
Always remember: “the stock market is a device for transferring money from the impatient to the patient” - Warren Buffett.
