Recession indicators: What may be next

Russell Price, Sr. Economist, Ameriprise Financial

Is the next recession coming soon? | Ameriprise Financial

September 2018

Key Points

  • The U.S. economic expansion recently entered its 10th year
  • This year's more turbulent markets have elevated recession fears
  • U.S. economic fundamentals are in a strong position to support continued growth, in our view

This past July, the U.S. economy officially entered its 10th year of economic expansion. The current period of economic growth is now the second longest period of uninterrupted growth in the post-World War II era. Its longevity has far surpassed that of the expansion post-1970 of just under six years, according to the Economic Cycle Research Institute.

But the question is: How long can this expansion last?

Growing recession concerns

Unfortunately, investors can be a nervous bunch. What might be cause for celebration has instead generated rising concerns over when the next recession might arrive. Such fears were further fueled this year by a few well-regarded “signals” that temporarily moved in a worrisome direction.

Potential recession signs and risks

Investors were particularly concerned by a flattening yield curve, which occurs when the spread between short-term and long-term interest rates narrows. From an economic perspective, we do not view the yield curve as overly concerning given the strength of the underlying economy.

Of course, rising trade barriers could yet evolve in a manner as to hinder growth, but an outright economic downturn would likely require a “worst-case scenario” in regard to trade. This is a possibility, but we believe rising economic consequences will eventually persuade leaders to compromise.

Despite the concerns, we believe the U.S. economy is currently well supported by solid fundamentals, and a recession seems very unlikely over the next 12 to 18 months, at the least. 

Slow, steady U.S. economic growth

There’s no doubt that a recession will eventually occur. But the current expansion’s relatively modest pace has not created the “boom” that often fosters the eventual “bust.”

Since the Great Recession ended in mid-2009 and until the end of 2017, U.S. real Gross Domestic Product or GDP (which is the broadest measure of economic activity) has averaged an annual growth rate of just 2.2%, according to the IMF World Economic Outlook July 2018 Update. In our opinion, this pace is very close to the economy’s sustainable rate.

In short, economic growth can be like a marathon where a steady pace is important for endurance, compared to a faster sprint that may be harder to maintain for long periods.

The role of a cautious consumer

A key factor contributing to this steady pace has been an uncharacteristically cautious consumer. Usually, as employment, income and confidence levels rise, consumers feel comfortable enough to take on more debt.

Eventually, debt levels become overly burdensome, causing people to pull-back on their spending to get their finances back in order. Considering that consumers in aggregate account for 70% of U.S. economic activity according to the U.S. Department of Commerce, changes in their spending can have a significant influence on the economy’s overall direction.

In recent years, however, this historical script has not been the case. Consumer debt has expanded but only modestly. Consumer debt relative to consumer income is still at very manageable levels, according to the Federal Reserve’s Financial Obligations Ratio and the personal savings rate of 6.8% in June1 is still surprisingly high by historic measures.  

We believe the U.S. economy is currently well supported by solid fundamentals, and a recession seems very unlikely over the next 12 to 18 months.

Talk of a recession in 2020

Some forecasters predict the next economic downturn could arrive in 2020. These projections are partially based on the fact that under the current federal budget agreement, government spending will decrease by approximately $150 billion in the fiscal year 2020 (which begins on October 1, 2019).

This past January, Congress approved additional spending of $150 billion for the fiscal years 2018 and 2019 for a total of $300 billion. When this incremental spending goes away in 2020, it could reduce economic growth in the U.S. by approximately 0.8% in the following year.

Recessions do not follow a calendar

Trying to “time” financial markets has historically been a fool’s game, in our opinion. While it may be wise to adjust portfolio allocations in light of certain circumstances, concerns can often be based more on emotions than fundamentals.

This is not to say, however, that risks have not increased. Inflation is very likely to accelerate this year, the Federal Reserve’s aggressiveness in raising interest rates will be important and current trade disputes are indeed a threat. At this time, however, we see these challenges as manageable and believe that sound underlying fundamentals should continue to support economic growth.

Although there may be much speculation about the direction of markets and the economy, a good approach is to focus on your goals and the most effective strategy to achieve them. Stay attuned to your long-term objectives, and work with your financial advisor to determine if any portfolio adjustments are needed to keep you on the right track.

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