Will A 35th Iteration Of This Night & Day Cycle Change Your Retirement?

Numerous warning signals of a coming recession have appeared recently, and there have been rapid changes in bond prices, stock prices, and Federal Reserve policies.

Yet, the stock market indexes are rising again, and the economic and financial fundamentals remain strong in many ways. Are the widespread fears of recession overblown?

In the search for answers, this analysis explores 164 years of economic history and the 34 previous "night and day" iterations of recession and expansion. By studying the average expansion and recession, many insights can be gained in terms of what economies look like shortly before the recession, and whether history shows that the current robust economic statistics are in fact a reliable argument against another recession starting within the next 1-2 years.

This analysis is part of a series of related analyses, an overview of the rest of the series is linked here.

Four Key Recent Developments

There have been four key recent developments when it comes to the likelihood of a recession within (about) the next one to two years.

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The first development can be seen in the graph above, which is that we remain very close to a potential yield curve inversion. As explored extensively in the analysis linked here, the unusual event of long-term yields being lower than short term yields has in past decades been a remarkably accurate warning signal that a recession will occur within the next 1-2 years. While an inversion has not actually occurred in the most watched areas, we are still the closest to an inversion that we have been since 2006.

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Most importantly the source of the near inversion at this stage is not the "floor coming up" in terms of Fed short term rate increases, but rather the "ceiling coming down" in terms of fast falling long term yields. As explored in the analysis "Three Beautiful Arbitrages (Why Yield Curve Inversion Happen)" (linked here), yield curve inversions are not some arcane technical indicator but are the result of a highly profitable strategy used by sophisticated investors who bring down long term rates in the process of executing the strategy - which is exactly what we have recently been seeing.

We've also had an extraordinary amount of volatility in the stock markets. Fears about trade wars, economic growth, slowing earnings and recession all played key roles in the fast declines in stock prices.

We've also seen a big change in Federal Reserve policy, specifically because of the issue that they are concerned about economic growth. After two years of steady interest-rate increases, in their December meeting, the Federal Reserve abruptly backed off from the prior regular message to the markets, which was to expect a series of future interest-rate increases.

Indeed if we look at statements by Chairman Powell and other voting members of the Federal Open Market Committee since the December meeting, the chances look high that the Fed has at the least paused the cycle. They no longer have a public plan for steadily increasing interest rates, but rather they will wait, see what happens, and react to developments.

It is interesting and important to note that the last time that the Fed stopped a cycle of increasing interest rates and hit the "pause" button to see what happened next - was the year 2006.  This was the same year as the last yield curve inversion, and the Great Recession followed in less than two years.

The previous time that there was a yield curve inversion and the Fed paused a cycle of increasing Fed Funds rates - was the year 2000. The collapse of the tech stock bubble and the sharp recession of 2001 also followed in less than two years.

The time before that can also be seen in the "Yield Curve Inversions & Recessions" graph, and it was the year 1989. A yield curve inversion occurred, the Fed paused a cycle of increasing Fed Funds rates that had been in the process - and the recession of 1990 followed, more or less right on schedule.

The Normality Of Recessions

For most people - recessions do not seem like a normal event. Why recessions occur is not intuitive for most people, so there is little reason to expect another one anytime soon. However, what history shows us is that recessions do occur, they are entirely normal and they are common.

The National Bureau of Economic Research has studied the United States economy back to December of 1854 and has attempted to identify each month of economic expansion and each month of recession during that time.  

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As we can see in the pie chart above, which is based on their research, the NBER estimates that the United States economy has experienced 113 years of expansion since 1854 - and 51 years of recession.

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Disclosure: This analysis contains the ideas and opinions of the author. It is a conceptual and educational exploration of financial and general economic principles. As with any ...

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