Stocks are falling. Interest rates are climbing. The yield curve is flattening and could soon be flashing red.
There’s plenty to worry about at the start of this new year.
But for those investors trying to adjust their portfolios for the impending recession that pundits have said will start in 2020, recent economic indicators have a warning: an economic downturn could begin in 2019 with the chances of a recession the highest they’ve been since November 2008.
Stocks fell as much as 20%, culminating in a dramatic slide on Christmas Eve, and have since enjoyed what appears to be a “dead-cat bounce.” The speed at which markets have moved—particularly the plunge in oil prices—signals the acceleration in timing of the next downturn.
Last month, OPEC and Russia agreed to reduce oil output by 1.2 million barrels per day beginning in January in an effort to lift prices. Despite this, the price of West Texas Intermediate crude has fallen by more than 40% from its high in early October. This fall can be attributed to the expectation that the demand for energy will fall even more than the reduction in output that the OPEC+ countries plan to implement.
As the U.S. and Chinese economies are showing signs of slowing expansion, the International Monetary Fund has lowered its global growth forecast for this year. And on Monday, it was discovered that China’s manufacturing purchasing managers index dropped to 49.4 last month, the weakest since the beginning of 2016 and below the level of 50 that marks a contraction.
The U.S. housing picture is also looking bleak as weaknesses are developing in housing starts, single-family home completions, and mortgage applications. Home prices have risen since the financial crisis against modest wage increases, reducing affordability and causing buyers to delay purchases even as the 30-year fixed mortgage rate fell to 4.54% in December from 4.82% in early November.
A further recession indicator flashed red last month when the Fed raised its benchmark rate for the fourth time in 2018. While the rate hike was priced in, the statement by Chairman Jerome Powell that rates would be raised a further two times in 2019 came as a shock to the market.
Powell’s words did further damage when he said that the Fed’s balance sheet assets were being reduced on “auto pilot” at a monthly rate of $50 billion.
And as the U.S. Treasury yield curves inverted briefly last month as yields on five-year notes fell below those to two- and three-year notes, the bond market signaled an increase in the likelihood of a rapidly impending recession. The market’s favorite recession indicator, the spread between the two- and ten-year Treasury yields, narrowed significantly to within 10 basis points following the rate hike and Powell’s statements following the December meeting.
If the last recession is any indicator, after the yield curve inverts, the spread between the two- and ten-year notes could again turn positive toward the end of 2019 if the Fed cuts rates. However, even as the yield curve turns positive, equities will likely be impacted by an ongoing recession and will probably be the asset class that experiences the brunt of the recession.