2023 Q3 Outlook

Economic predictions have been somewhat volatile as well, with consensus going from soft landing to recession to no recession and no tilting back to recession, but this is controversial.  I see a recession in the near future as the most likely outcome, and will lay out the case for that view.

First, the Conference Board Leading Economic Index has successfully predicted the last eight recessions going back to 1971, with no false signals… yet.  Declines of 5% of more have always been followed by a recession within 7-20 months from the index peak.  This cycle is 21 months from the peak, which could be the longest lag if we don’t subsequently find out the recession has already started.  Since the index is still falling, it is more reasonable to conclude that the recession is just taking longer to start (perhaps due to excess cash reserves and pent-up demand due to COVID closures) than that this time will not be accompanied by a recession.[1]

Second, an inverted yield curve also have preceded each recession since the 1950’s, although the time lag has been all over the place. This is when the long-term interest rate is lower than the short-term rate.

While those two indicators carry the most weight in my mind due to their long and impressive history, there are other signs pointing toward a recession, or at least a considerable slowdown.  One is understanding what enabled the long economic boom – extremely accommodative policy by the Federal Reserve, in the form of low interest rates and increasing its balance sheet.  All of that money had to go somewhere, and it ended up driving up all asset prices (stocks, real estate, etc.), giving rise to speculations such as Meme stocks, blank-check companies, cryptocurrencies, NFTs, and finally boosting consumer spending.  Related to that was rising home prices and low-cost equity loans that allowed people to comfortably spend more than they earned.  That trend is over now, as the Fed slowly decreases its balance sheet back toward a normal size and as rates are back to more of a normal long-term level.   

Read the full update here: 23 3Q Econ upate.pdf

[1] Another theory, held by respectable economists such as Jerry Bowyer and Ed Yardeni is that we have experienced a rolling recession, which never registered as a recession because different parts of the economy experienced it at different times, while the non-recession areas generated enough growth for the whole economy to narrowly avoid a formal recession.  Data support this view, but current leading indicators are still pointing to a looming recession.