In January last year I penned a piece whose simple thesis was clear from the title (see Towards An OECD Recession In 2015). The idea was that each time the rentier owner of capital made more money than the entrepreneur (on a worldwide basis) in the previous 12 months, a recession in the OECD materialized some time in the next 12 months. Returns for the rentier were computed using the 12-month total return of 10-year treasuries and those for entrepreneurs using both the World MSCI and the Goldman Sachs commodities index. The point was that a recession usually followed periods when US treasuries had outperformed both measures of entrepreneurial return for a significant period.
Given the big role of the US economy in the OECD, the next step was to build a more specific tool (see Gauging The Chances Of A US Recession). This indicator had moved into worryingly negative territory by the end of 2015 to the point that a US recession looked probable by mid-2016. Since recessions tend to be officially verified only once they have finished, I employed a confirmation tool in the shape of US industrial production (12m rate of change, 6m ma). The approach was chosen as since 1945 this measure of industrial production has never swung deeply negative without the National Bureau of Economic Research later classifying it as a recession.
Two things have happened since the start of 2016:
1) The chosen measure of industrial production has turned negative, which, based on post-WWII experience, points to a looming recession. And this begs the obvious question of whether such an outcome has already taken effect. After all, the US economy has not looked particularly robust of late, while corporate profits are declining as they usually do in a recessionary environment.
2) The recession indicator, which slid to register a -11 reading has recovered to around -1, and thus has left the danger zone of -5 or below. What lies behind this pickup is the ISM index and the Chicago Purchasing Managers Index moving back above 50, the rally in Dow Transport equities, and an improvement in the real monetary base.
Given these apparent contradictions, the question is what to do next?
The answer is: not much. The recommended 50:50 portfolio of bonds and equities continues to outperform. From the date when I recommended adding a defensive hedge (after the recession indicator slid to –5, see Positioning For A US Recession) the S&P 500 total return index is up 10% while treasuries are up 10.6%. Moreover, the volatility of the balanced portfolio has been very low indeed compared to the volatility of the equity market.
To be clear:
- Growth is not that strong in OECD economies outside of the US and the rentier continues to outperform the entrepreneur. The most recent OECD industrial production reading (December 2015) is down on a YoY basis.
- US industrial production reading remains weak and most of the improvement can be attributed to better “sentiment”.
- At turning points in the economy, the “statistical noise” can be extremely high.
In summary, I continue to monitor the situation and am not offering a changed investment recommendation.