U.S. Business Cycle

Economy In Danger Of Overheating?

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.

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Q2 hedge fund letters, conference, scoops etc

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

U.S. Business Cycle

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

U.S. Business Cycle

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)

U.S. Business Cycle

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)

U.S. Business Cycle

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

Global PMIs

Largest global economies’ Manufacturing PMIs (Purchasing Managers Index)

U.S. Business Cycle

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

U.S. Business Cycle

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)

U.S. Business Cycle

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

U.S. Business Cycle

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.)

U.S. Business Cycle

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

We are working hard to make these chart books available to you, but, as you might imagine, have considerable cost in preparing them. By becoming premium subscribers, you can support this project. Axel's Take is Merk President & CIO's 'in between the lines' reading of what these charts mean; whereas the chart books try to data speak for themselves, Axel expands on his views, in this case on where markets may be heading and what it might mean for investors. If you subscribe now, the price is only $10 a month for access to all premium reports that also include select premium chart books and other benefits. You can cancel any time. Click here to view Axel's Take. For a limited time, we are providing Axel's Take for free if you use the custom link below.

The investing audience should view this content in the context of their individual investment process, time-horizon, and goals.

Publication Date Chart Book Category PDF Video Additional
August 08, 2018 Business Cycle
August 1, 2018 Fed Chart Book
July 18, 2018 U.S. Equity Market
July 12, 2018 Business Cycle
June 14, 2018 U.S. Equity Market
June 13, 2018 Fed Chart Book
June 6, 2018 Business Cycle
May 23, 2018 U.S. Inflation
May 16, 2018 U.S. Equity Market
May 9, 2018 Business Cycle
May 2, 2018 Fed Chart Book
April 19, 2018 U.S. Equity Market
April 10, 2018 Business Cycle
March 21, 2018 U.S. Equity Market
March 14, 2018 Business Cycle
February 14, 2018 U.S. Equity Market
February 7, 2018 Business Cycle
January 17, 2018 U.S. Equity Market
January 10, 2018 Business Cycle
December 12, 2017 Business Cycle

(*) For a limited time, we are offering access to our premium service at a low monthly fee of $10. When this rate increases, we will grandfather subscribers at the $10 level for at least another twelve months at this low rate.


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