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Our Q4 Recession Dashboard
by Franklin J. Parker, CFA | A look at market volatility in light of our recession dashboard
2018 has been a wild ride for investors, and this latest batch of volatility has many investors scratching their heads. In this quarterly edition of our recession dashboard we will dig into not only the fundamental economic data, but also our view of recent market turbulence and what it means to you and your goals.

Our Recession Dashboard

First on our dashboard is the change from last year in delinquency rates on commercial loans. As illustrated in the chart above, delinquency rates tend to rise leading into a recession. This makes intuitive sense, as an early sign of trouble are businesses which have trouble paying their bills. As you can see, delinquency rates have shrunk over the past year, and have been shrinking. This is a positive sign for our economy.

The next indicator is the Purchasing Manager’s Index, which surveys manufacturing activity in the US. With current levels around 60, this figure is nearly as high as it ever gets. This indicates a strong manufacturing outlook in the US. Typically, before a recession, we see these figures at 50 or below. While not impossible, by historical standards it would be highly unusual to see a recession with PMI at levels greater than 55.

The next chart shows earnings growth from a year ago for the companies in the S&P 500 stock index. This indicator tends to be noisy, and while you often get earnings contractions with no recession (like we saw in 2015 and 1997), historically it would be unusual to have a recession in the midst of 20%+ earnings growth, which is the growth level we are seeing currently. In our view, strong profit growth tends to generate higher prices, though that will be volatile in the short term.

Likely the most widely-followed recessionary indicator, the US Treasury yield curve is showing that we are late-cycle, but not quite at the end. The chart above takes the 10-year US Treasury yield and subtracts the 3-month US Treasury yield. In normal environments, you should be paid more to tie up your money for 10 years than you do for 3 months. However, ahead of a recession, this relationship tend to invert, paying investors more to tie up money for 3 months than for 10 years. As you can see, we haven’t reached that point yet, though we are getting closer.

These are just a few of the many business cycle indicators we follow closely, but they are representative of the picture we are currently seeing. Our view, informed by the data, is that we are late in this economic cycle, but not at the end yet. We see more room to grow. Therefore, in our view, this recent market turbulence is likely to be short lived, and is a good entry point for long-term investors with cash on the sidelines.

What is happening, short-term, in markets
Given that we do not see the current market swings as the results of a recessionary environment, we think of the most recent market movements as a short-term repricing. These kinds of repricings occur about once every three to four years and while they may be painful, they are often fairly short-lived. What’s more, they tend to set the stage for a firm move higher.

In the chart above, we see the S&P 500 move from 2011 to 2015. As you can see, over that four year period, the lows tended to follow the green line (labeled A). However, in August of 2015, markets firmly broke that line (B), then traded sideways for about six months (C). Eventually, markets found a new line, and began to move higher.

We can see similar market action in the most recent October move (chart below). The line established at the beginning of 2016 establishes the lows of market selloffs (A), including the one in January of 2018. However, we can see that the recent move in October 2018 (B) pushes prices well below that line, indicating a possible sideways move for some period of time.

We expect this to be a short period of time, given the very positive fundamental economic data. Of course, one can never know for sure. Speaking historically, these moves typically last anywhere from three to six months before finding a bottom. 2015 was on the long end of that spectrum. Given that 2015 also posted numerous poor economic numbers, that fact should be no surprise. Our expectation is that stronger data will likely yield a shorter repricing period.

Putting it all together--what do I do?
As always, what you do with this information is dependent on numerous factors—your goals and risk tolerance included. For investors with several years before reaching their goals, these dips are wonderful entry points for cash. For folks approaching their funding needs, caution would be warranted before wading into turbulent markets, as the length and depth of this market is not known until after the fact.

We are reminded in this environment that this is the risk which investors are paid to bear. “Risk” is often a bad word. What we learn in finance, however, is that we can only gain by putting something at risk. It is risk which fuels investment returns. Despite the short-term pain, we are ultimately thankful it exists.

All information provided herein is for informational purposes only and should not be relied upon to make an investment decision. This presentation is neither an offer to sell, nor a solicitation of any offer to buy any securities, investment products, or in-vestment advisory service. The presentation is being furnished on a confidential basis to the recipient.

The information herein contains forward looking statements and projections representing the current assumptions and beliefs based on information available to Bright Wealth Management, LLC at time of publishing. This information included is believed to be reasonable, reliable and accurate, (however no representation is made with respect to the accuracy and completeness of such data) and is the most recent information available (unless otherwise noted). However, all the information herein, and such beliefs, statements and assumptions are subject to change without notice. All statements made involve risk, uncertainties and are assumptions. Investors may not put undue reliance on any of these statements. There is no guarantee that the market will move in any direction, as there is no way to predict with certainty future market behavior. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make an informed investment decision based on individual objectives and suitability.

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