As part of Merk’s in-house research we regularly evaluate a consistent set of charts covering the economy, equities, fixed income, commodities and currencies. The aim is to keep our eyes open and to look through the noise of the headlines, avoiding the distractions of sensationalized click-bait. In sharing this content, we offer a cross-check to your own thinking and aim to add value to your own process.
As part of Merk's in-house research meetings, we are sharing with you our latest analysis of the U.S. business cycle.
"...at this stage of the business cycle, the output gap has closed and the economy is in danger of overheating. "
We invite you to download a copy of the chart book (PDF); or to view the video:
U.S. Business Cycle Chart Book
Why is the Business Cycle Important?
S&P 500 (log scale) and official National Bureau of Economic Research (NBER) U.S. Recessions
Analysis: Over the 90 years between 1927 and 2017, the average S&P 500 monthly return during expansions was +0.89% (889 months), compared to an average S&P 500 monthly return during recessions of -0.71% (191 months). In terms of proportions of time: expansion months account for about 80% and recession months about 20%. The business cycle also has important implications for Fed policy. *Note that recessions are not announced by the NBER until well after their start dates*
Leading Economic Indicators (LEIs) Index
YoY rate of change of the Conference Board’s LEI Index
Analysis: the LEI YoY rate of change decreased since last month’s report: from +6.1 to +5.8
Given that the YoY rate of change is positive, history suggests a recession is unlikely to start within the next six months; however, the downtrend in the YoY rate of change makes me slightly less positive on this picture
Chart Framework: I’d get incrementally negative on the business cycle outlook if the LEI YoY went negative
U.S. Yield Curve Steepness
(10yr yield – 3yr yield)
Analysis: Yield curve is still positively sloped
The yield curve is approaching inversion, which may happen before year end
Chart Framework: I’d get incrementally negative on the business cycle outlook if the yield curve inverted (i.e., 3yr yield > 10yr yield)
Manufacturing and Non-manufacturing (aka Services) PMIs (Purchasing Managers Index)
Analysis: Manufacturing PMI ticked down from 60.2 to 58.1 since last month’s report, still holding up near the high end of the multi-decade range
Chart Framework: I’d get incrementally negative on the business cycle outlook if manufacturing PMIs fell below 50
Largest global economies’ Manufacturing PMIs (Purchasing Managers Index)
Analysis: Global economic momentum was mixed over the past month, all but one reading still above 50.
Russia below 50 for the past three months.
Chart Framework: I’d get incrementally negative on the business cycle outlook if China, India, Germany or Japan manufacturing PMIs fell below 50
U.S. Unemployment Momentum
U-3 Rate and U-3 12 month Moving Average
Analysis: Unemployment rate ticked lower to 3.9%, still below its 12-month moving average (with the labor force participation rate stable – not shown)
Chart Framework: I’d get incrementally negative on the business cycle outlook if the unemployment rate moved above its 12m MA while the labor force participation rate trended lower
SF Fed Leading Unemployment Rate (U-3) Model
Replica of San Francisco Fed Model (grey) and U-3 Unemployment Rate (black)
Analysis: The SF Fed unemployment rate model (grey line) continues to trend lower, which suggests the U-3 rate (black line) should continue to trend lower
Chart Framework: I’d get incrementally negative on the business cycle outlook if the SF Fed model line trends higher on a YoY basis
U.S. Labor Market Capacity Utilization
Natural Rate of Unemployment (CBO est.) – Actual Rate of Unemployment
Analysis: The estimated natural unemployment rate is greater than the current unemployment rate (4.62% – 3.9%), meaning the U.S. economy is potentially running above capacity, which likely increases the risk of a recession roughly 1-5 years out.
Chart Framework: I’m currently incrementally negative on the business cycle outlook (medium/longer term) based on this picture
U.S. GDP Output Gap
Actual GDP minus Potential GDP (CBO est.)
Analysis: Actual GDP is slightly less than potential GDP (as estimated by the CBO), which suggests the expansion might have further to go before the “output gap” closes
Chart Framework: I’d get incrementally negative on the business cycle outlook (medium/longer term) if the output gap closed, meaning actual GDP > potential GDP
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