Monthly Macro Monitor: We’re Not There Yet

“How did you go bankrupt?” Bill asked.

“Two ways”, Mike said. “Gradually and then suddenly.”

 - The Sun Also Rises, By Ernest Hemingway

I first wrote about the current economic slowdown a year ago and Jeff Snider actually started seeing signs of slowdown in the Eurodollar market as early as May 2018. So, the slowdown we’re in now certainly isn’t a surprise here at Alhambra. I think though that we often forget how long these things take to develop. When we look back at past recessions it seems as if things happened quickly but reading about a recession, or more accurately the onset of recession, is a lot different than living through it. Like Mike’s bankruptcy in Hemingway’s masterpiece, recession comes on gradually…and then suddenly.

The most widely known – now – indicator of recession is the inversion of the yield curve when short term interest rates rise above long term rates. There are many versions of “the” yield curve but I have always used the 10-year and 2-year Treasury notes. It has inverted prior to every recession in recent memory and because of its accuracy is now widely followed. But as I’ve pointed out many times in these notes, it isn’t the inversion that signals recession but rather the rapid steepening that occurs as short term rates fall rapidly in anticipation of Fed rate cuts. Inversions do come before recession but sometimes it is way before recession.

In the cycle that preceded the millennial recession that started in March of 2001, the yield curve (10/2 curve) first inverted in June of 1998 although it only lasted less than a month. The final inversion started in February of 2000, a full year before the onset of recession. In the last business cycle the curve initially inverted in February of 2006, 22 months before the start of the recession. It turned positive and then inverted again in June and August of ’06. It turned positive again in March of ’07 and inverted the final time in May of ’07, still seven months before the onset of recession. Obviously, that’s a lot of lead time before recession and one should note that often some of the biggest gains in a bull markets happen at the end. So, bailing when the curve first inverts is far from an ideal strategy. This is the “gradually” part of the onset of recession.

The “suddenly” part of the onset of recession is the steepening that happens after the inversion. In the 2001 recession the curve steepened 125 basis points over 11 months from its nadir. And once it turned positive again – long term rates higher than short term – it was only three months before recession hit. In the 2008 version, it took a bit longer. From maximum inversion to recession took six months. That’s not too early and not too late because history says you actually have some time even after recession starts to adjust your portfolio. If you can hit a window that stretches from six months before to six months after the onset of recession you are going to be way ahead of the crowd. Act too soon and miss too much upside, act too late and get killed when the bear hits.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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