Your early warning signs for the next recession — or not

Friday, 24 August 2018
Melbourne, Australia
By Terence Duffy

  • On and on it goes
  • The charts to watch
  • The signs to look out for when a recession finally comes

It’s very easy to get caught up in all the day-to-day noise of the stock markets around the world. The S&P 500 was up a hundred points, the Dow Jones down six hundred points, and on it goes.

The stock market will show volatility from time to time. And right now has been one of those times, not least due to the political chaos in Canberra this week. In time like this, always keep the overall trend in mind.

There’s plenty of things you can look at to work out where you are in the economic cycle – and what’s coming next.

You should not be getting bearish when US homebuilders like Lennar Corp [NYSE:LEN] are posting strong results. They reported first-quarter earnings back in April. New-home orders rose 30% and the strong result surpassed analysts’ expectations.

Housing starts are a good way to gauge how any economy is tracking.

Buying a house is the biggest purchase a consumer will ever make. Current Lennar results indicates consumer confidence and a strong jobs market.The company is not standing still. Bloomberg reports the homebuilder has been collaborating with a tech start up known as Opendoor, to make it easier for their customers to offload their houses and trade up to new ones.

The principle is similar to trading in the old car to buy a new one. It’s something that hasn’t really existed before for homes and Lennar reports their customers love it. Opendoor simplifies home transactions and can put together an offer within 48 hours. If the homeowner accepts, Opendoor then buys the home, makes repairs and quickly puts the property back on the market.

Lennar customers using the service don’t have to worry about selling their home, and they already have a ready buyer. And they don’t have to carry two mortgages while waiting for their old house to sell.

So whilst homebuilders like Lennar are reporting pretty good profit results, you can’t get too bearish on the economy.

And while political knifings and moves in interest rates grab all the headlines, keep in mind the all-important yield curve, which has been steadily flattening since 2016.

More after a quick look at the markets…

Markets

Overnight the Dow Jones Industrial Average closed down 76.62 points, or 0.30%.

The S&P 500 fell 4.84 points, or 0.17%.

In Europe the Euro Stoxx 50 index finished down 0.92 points, or 0.027%. Meanwhile, the FTSE 100 lost 0.15%, and Germany’s DAX fell 20.12 points, or 0.16%.

In Asian markets, Japan’s Nikkei 225 is up 181.51 points, or 0.81%. China’s CSI 300 is up 0.77%.

In Australia, the S&P/ASX 200 is up 9.60 points, or 0.15%.

On the commodities markets, West Texas Intermediate crude oil is US$68.33 per barrel. Brent crude is US$75.54 per barrel.

Gold is trading for US$1,188.34 (AU$1,632.42) per troy ounce. Silver is US$14.56 (AU$20.01) per troy ounce.

One bitcoin is worth US$6,518.03.

The Aussie dollar is worth 72.84 US cents.

The charts to watch

The gap between the Fed funds rate and the 10-year treasury yield has been narrowing. And while we should not worry about a flatter yield curve right now, going forward we could watch for any yield curve inversion. Something we study for you over at Cycles, Trends & Forecasts.

An inverted yield curve is when the long-term bond yields fall below short-term yields and is a reliable indicator of recession.

Here’s a chart from earlier this year:



chart image

Source: Cycles, Trends and Forecasts
Click to enlarge


The real estate cycle aside, this is a further reason why I have been able to dismiss talk of prior market collapses. Not only this year in February when the Dow Jones suffered its worst single biggest point drop in its 132-year history. But also going back to the January 2016 panic, when US equity markets recorded their worst start to a year on record.

Or a little further back, the panic of August 2015, when the Dow plunged an unprecedented 1000 points at the open.

The chart clearly shows that markets have never collapsed while the yield curve was so positively sloped. (If you don’t know what that means, then you need to go here.)

Recessions occur way after the Fed starts its tightening cycle, not at the beginning. It’s roughly 3.5 years on average after the Fed starts to raise rates that a recession may occur — or not. The Fed started raising in December 2015, so that gives you something to watch for after mid-2019. Perhaps.

You see, the Global Financial Crisis was not actually a financial crisis. It was first and foremost a land crisis. It’s real estate that drives the economic cycle. It’s in the land market where the stresses will turn up first. The chart of Lennar Corporation [NYSE:LEN] clearly shows this.



chart image

Source: Google Finance
Click to enlarge


Lennar is the major homebuilder in the US. It’s a company you could follow to see how the real estate cycle is tracking.

We’re still in the first half of the real estate cycle and homebuilders are still playing catch up, because of the millions of homes that were never built in the years following 2008.

The chart suggests this company may have a big second half to the real estate cycle. It’s maybe one to watch in the months and years ahead.

No one rings a bell at the top, but come 2025 or so, you could be watching this stock to signal a major market turn.

At the time you might read some prominent person saying the economy has never been in better shape and the business cycle has been confined to the dustbin of history.

All the major indices might still be breaking higher into all-time highs, but if you’re seeing housing stocks like Lennar breaking monthly lows, well, you know what might be coming next.

It’s all to do with the land market. Knowing that, and the sequence and timing of the real estate cycle, is your trading advantage. (The mid-cycle slowdown is what we watch for next.)

If you want that knowledge on your side, then go here.

Finally, for those interested, here’s the latest on our political leaders and their infighting, from The Australian Tribune:

‘Turnbull’s Turn is Over, Now Let’s Get on With It’

It’s official, Australia’s 30th Prime Minister is none other than Liberal’s — now former — treasurer, Mr Scott Morrison.

After knocking Foreign Minister Julie Bishop out of the race early on, it became a battle in which the best man would win, determined by a Liberal party room vote. The ballot gave a 45–40 result, with Morrison coming out on top over Peter Dutton.

A close call, no doubt. This came after the spill almost didn’t happen. A mere three more votes for Turnbull would have once again secured his spot as PM…

If you’re fed up with sanitised, politically correct dogma cut and pasted from one mainstream source to another, then The Australian Tribune is for you.

And it’s absolutely free.

Sign up here to get The Australian Tribune delivered free to your inbox five days per week.

You can visit our website at https://www.theaustraliantribune.com.au/ to read the complete article above now.

Terence Duffy,
Lead researcher, Cycles, Trends and Forecasts