A recession is what usually concerns many investors, and economists. But exactly how they estimate the probability of a recession is often unclear to me. And sometimes not much of the «approach» is correct either. Given the significant potential impact on different asset classes, it makes sense to attempt to get a grip on it myself.
One component with which I try to get that grip is with my US Recession Scoreboard. This contains 11 indicators that historically have a reasonable track record with regard to recession forecasts. Of course, the usual suspects, such as the yield curve, Fed rate policy, and the ISM Manufacturing Index are amply represented. The somewhat less obvious indicators are the ones that add conviction.
For instance, US building permits fell a solid 8.8 per cent in March, suggesting a new dip in the US housing market. Building permits, as well as homes under construction, are a much better recession indicator than home sales and prices, which always get a lot of attention, because the economic activity is in building a house rather than transferring ownership.
The chart below shows that any major drop in building permits was followed by a recession. The latest figures therefore push up the probability of a recession, which is also reflected in the table above.
Gold and silver
The gold-silver ratio has fallen by more than 10 per cent since the beginning of March. The ratio can be seen as a cyclical indicator. Gold, which has relatively few industrial uses, yet is mainly seen as the undisputed safe haven, tends to rise against silver when growth prospects deteriorate. Conversely, silver, which is used in various industrial processes, does better when the business cycle improves.
The chart above shows the relationship between the gold-silver ratio and US GDP growth. Certainly not a perfect relationship, but enough to take into account, not least because of gold’s increasing role in investment portfolios, as well as central bank reserves. From a historical perspective, the gold-silver ratio is high, but with the recent 10 per cent-plus drop, the likelihood of a recession from this perspective diminishes (slightly).
So is it coming?
Judging from the US Recession Scoreboard, the likelihood of us having another US recession is significant. Moreover, I think corporate bond spreads are still on a pink cloud, untouched by banks› tighter lending requirements, which generally means more bankruptcies. So my view is that this recession is indeed coming.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every week on Investment Officer.