Stocks and Bonds are Now Both Right – No Recession in Sight

Expect Stocks to Make New Highs as the Economy Firms Up

Recession fears are everywhere. The US-China trade war, Middle East violence, impeachment in DC, protests in Hong Kong, and Brexit have all weighed on the economy. These fears are likely overblown. Consumer economic data remains robust and the Fed has cut rates twice as manufacturing has softened. US stocks have posted robust gains. And the 3 month/10 year spread in Treasuries has uninverted.

I wrote in August that Optimism is on the Menu; A Recession is Not: US stocks were 90% likely to gain 6.7% in the next 12 months. Since that date, the S&P 500 has risen by 4.3%. I am now expecting the S&P to post new all-time highs and gain about 11% over the next year. These return projections come from my Market Model. The model is a fully-connected neural network ingesting 164 data points back to 1992. Full code is on my GitHub under post 63.

Market Model Training and Validation Results

The Consumer is Strong

The consumer drives the US economy. So far things are holding up well.

Consumer sentiment has rebounded in October:

Retail Sales growth continues:

Consumer spending growth remains steady:

There has been no noticeable increase in layoffs:

Manufacturing Has Slowed, But The Fed Has Acted

Manufacturing has weakened. The September ISM PMI recorded its lowest reading since June of 2009 at 47.8 and has been falling for months. Per the ISM, the PMI is a “composite index based on the diffusion indexes of five of the indexes with equal weights: New Orders (seasonally adjusted), Production (seasonally adjusted), Employment (seasonally adjusted), Supplier Deliveries (seasonally adjusted), and Inventories.”

I found that the summary PMI index to be most correlated with three of these sub-indexes: New Orders, Production, Employment.

import numpy as np
import pandas as pd
import matplotlib.pyplot as plt
from pathlib import Path
path = Path("Desktop")
df = pd.read_csv(path/'Market Data - ISM2.csv')
corr = df.corr()
fig = plt.figure()
ax = fig.add_subplot(111)
cax = ax.matshow(corr,cmap='coolwarm', vmin=-1, vmax=1)
fig.colorbar(cax)
ticks = np.arange(0,len(df.columns),1)
ax.set_xticks(ticks)
plt.xticks(rotation=90)
ax.set_yticks(ticks)
ax.set_xticklabels(df.columns)
ax.set_yticklabels(df.columns)
plt.show()
Correlation of Composite Indexes With PMI (Monthly Data From 1948-2019)
Source: Institute for Supply Management

I created a new equal-weighted composite of these three indexes. Since 1980, in every expansion, this new index sustained a drop from a relative high into the 45-49 range. There is price memory at these levels, and 2019 is no different. Each drop coincided with mid-cycle Fed rate cuts. In 1985-86, 1995-96, 1998, and 2002-2003, the index rebounded and the expansion continued. The Fed is banking on the same outcome here.

Sources for Raw Data: Institute for Supply Management; Federal Reserve

There are other green shoots to point to.

The manufacturing slowdown in the U.S. may be driven by temporary influences such as the GM strike.

Certain bellwether industrial companies such as Fastenal are posting strong results.

The IHS Markit US Manufacturing PMI was 51.1 for September 2019, its highest reading since April.

The Empire State Manufacturing Survey has rebounded since June:

As has the Philly Fed Index:

The Trade War is Far From Over

As I wrote here in August, do not expect a trade deal before the 2020 U.S. presidential election. Only political desperation will drive a grand bargain. Impeachment proceedings in D.C. and continued protests in Hong Kong have weakened both leaders. This may be driving the recent negotiations and talk of a mini-deal. Look to President Trump’s poll numbers in the Midwest and to his support in the Senate for his next move on trade. Look for how far unrest spreads in China for insight into President Xi’s intentions. In the meantime, the current mini-deal seems unstable as best and fake news at worst.

President Trump enjoys touting stock market gains. What he is currently seeing is a market that has withstood his trade war. Since the January 22, 2018 start of the trade war (Wikipedia), the S&P 500 has gained 4.8%. Those are not world-beating returns…oh wait, they are. (source: Yahoo Finance)

Index1/22/1810/11/19Return
S&P 5002,832.972,970.27+4.8%
FTSE 1007,231.97,247.08+0.2%
DAX Performance Index13,463.6912,511.65-7.1%
Nikkei 22523,816.3321,798.87-8.5%
Shanghai Composite3,501.362,973.66-15.1%
Hang Seng32,393.4126,308.44-18.8%

The President surely keep tabs on GDP growth. It’s natural to fear a Carter or Bush 41 recession. A same-party or credible third-party challenger could doom reelection. So far, the US economy continues strong growth (source: Bureau of Economic Analysis):

QuarterQ1 ’18Q2 ’18Q3 ’18Q4 ’18Q1 ’19Q2 ’19
GDP Growth %2.53.52.91.13.12.0

Public Sector Driven Risk Has Yet to Take Us Down

I have written here, here, and here that society operates in shifting cycles of confidence between the public and private sectors. We are in a private-sector driven cycle where technology, capital, and private enterprise are ascendant. In these cycles, the greatest risks emerge from the out of power group. A miscalculated move by a public sector actor can derail progress. The US-China trade war is a poster child of these actions. But, to date, the US economy has held up pretty well. I expect it to continue to do so.


Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.

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