Recession risk is up based on recent economic indicators, but it’s not high, according to experts from Charles Schwab and LPL Financial.
While the Conference Board’s Leading Economic Index unexpectedly declined 0.2% in August, Liz Ann Sonders, Schwab’s chief investment strategist, believes this has “yet to signal a definitive turn for the worse.”
The Leading Economic Index, which Sonders calls the “most-widely followed set of leading indicators,” is designed to signal peaks and troughs in the business cycle. The Leading Economic Index tracks 10 diverse economic indicators, including data on employment, manufacturing, housing, bond yields, the stock market, consumer expectations and housing permits.
(Sonders is speaking at the most heavily attended preconference session in the industry at Schwab Impact 2016 in San Diego on Oct.27)
Over the past 50 years and eight recessions, the Leading Economic Index peaked well in advance of the onsets of recessions—on average by more than 12 months, Sonders said.
“And in the case of the three most recent recessions, the LEI had ‘round-tripped’ (taken out its prior high) at least four years prior to the subsequent recessions,” Sonders writes in her latest commentary. “So, if a recession is imminent today, it would be unprecedented for the LEI not to give sufficient warning.”
Sonders wrote, “Yes, August’s reading was negative and worse than expected, but as noted, there are usually months and months of deterioration before recessions ensue. August is also a month notoriously prone to economic data revisions—especially jobs-related data. So, the net is it’s too soon to declare victory for the economic bears.”
Burt White, chief investment officer for LPL, agrees that the Leading Economic Index is signaling the continuation of the economic expansion and bull market, according to his weekly market commentary.
White looks at the year-over-year change in the Leading Economic Index, which he calls the “best snapshot of the overall health of the economy,” to determine if the economy is showing late-cycle warnings. LPL’s analysis indicates that the year over year change in the Leading Economic Indicator has to turn negative to indicate a recession.
“When the year over year change has turned from positive to negative, a recession has followed in anywhere from 0–14 months with an average lead time of six months,” White wrote.
However, the year over year change in the Leading Economic Index as of August 2016 was +1.1%, which White said suggests “a continuation of the economic expansion that began in 2009.”