Recession In 2024? 4 Indicators You Must Follow (SPX)

Thesis Summary

In 2022, everyone was expecting a recession in 2023. Now, we are one month away from ending the year, and there is no recession in sight. In fact, we have seen plenty of evidence to suggest quite the opposite. The US economy is doing very well for now.

With that said, things can change very quickly, and 2024 could indeed be the year when the recession hits, just when everyone least expects it.

In this article, I look at four different indicators that can help us track the possibility of a US recession. What are these indicators saying now, and what will they look like 6-13 months from now?

US still Strong

The most recent economic data released this week continues to support the idea that the US economy is in remarkable shape.

The most recent GDP data shows that the economy grew at 5.2% over the last quarter. Meanwhile, the job market continues to be tight with jobless claims falling again in the last release:

It’s hard to make a case for a hard landing here, and it seems everyone would agree.

Ironically, this itself can be seen as a contrarian indicator. The number of news articles mentioning “soft landing” peaked just ahead of the 2001 recession and the 2008 recession.

As I’ve mentioned before, a soft landing is often just the initial stages of a hard landing.

Leading Economic Indicators

Leading Economic Indicators, as the name suggests, are a pretty straightforward way of trying to anticipate changes in the economic landscape.

It is made up of various components as we can see below.

Things like credit, manufacturing, wages and GDP are all measured to create the Conference Board LEI.

This is how the US’s looks today:

The shaded areas show previous recessions, which we can see have coincided with periods of highly negative YoY change in the LEI.

And while many of the LEI declined in 2022-23, we could have now reached a bottom as the LEI begins to turn. Notice also how Real GDP has sharply changed course.

Based on the LEI, one would be inclined to believe the US may have narrowly avoided a recession.

Sahm Rule

“Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to its low during the previous 12 months.”

Source: Wikipedia

St Louis Federal Reserve developed this on October 19th, and is a way of identifying the rate of change of unemployment.

Back in 2002 and 2009, the Sahm Rule did reasonably well at “predicting” the recession. However, it is true that by the time the indicator had reached 0.5 we were already in a recession. In 2001, we entered a recession when the indicator reached 0.3, and in 2008, when it reached 0.4.

In both instances, though, one would have done well to sell when this indicator reached 0.4:

Today, the Sahm indicator sits at 0.33

Though unemployment is still low, it has been deteriorating. If this were to reach 0.4, it could be a reason for alarm, in my opinion.

Yield inversion

The Yield inversion is another very popular indicator that is often touted. Yield inversions have been very good at predicting recessions in recent years:

The chart above shows the spread between the 10YR notes and 3-month bills. First, let’s note that when speaking of inversions, we can use many different versions. Another popular one is 10YR-2YR, for example. As we can see here, a yield inversion has preceded the last four recessions.

But why? What does an inverted yield curve mean exactly?

The yield curve tends to invert when the long-term end of the curve begins to fall. This happens as a recession begins to be priced in, and growth rates are expected to fall. The yield then inverts, and a recession comes following the un-inversion.

Generally, the yield uninverts as the Fed starts lowering the Fed Funds, affecting the curve’s short-end.

In recent months, the Yield curve began uninverting as the long end of the curve began to rise. This is known as a bear steepening. Which isn’t generally good, as the name suggests.

However, in recent months, long-term rates have begun to ease. Could they have stopped already?

In 2024, the Fed is expected to begin cutting rates, which would contribute to an inversion of the curve. But in and of itself, a few rate cuts should not hurt the market. In fact, the market would likely cheer these rate cuts.

In 2019, markets rallied as rates were cut. It’s only when rates are cut quickly once a recession is already clearly underway that we can find a “correlation”. But, if anything, recessions cause rate cuts, not the other way around.

M2

M2 is a measure of broad money, which includes cash and deposits. It is generally seen as a good indicator of the health of the economy. Lower M2 means deposits are shrinking, perhaps due to tighter lending standards.

The chart above shows the evolution of the SPC and the YoY change in M2 in the pane below. As we can see, changes in the growth of M2 can be good indicators of market tops and bottoms. For example, in 2020, markets rallied as M2 was decreasing, and soon after, we had a top. Markets then topped in 2021 as M2 growth peaked and bottomed when it went negative.

M2 has now begun growing, which is supportive of a stock market rally. In 2024, global central bank rate cuts should be supportive of more M2 growth, as lower rates facilitate lending/borrowing.

Takeaway

These indicators laid out above can help us determine where the economy is going, but none can provide us with certain answers. Macro is as much art as it is science, and everything has to be interpreted. Rules are made to be broken, and past events aren’t necessarily indicative of what will happen in the future.

My own take? Given the growth in M2 and the coming rate cuts, combined with the current strength in the US economy, I think the stock market will rally in the first half of 2024. Markets will cheer the soft landing narrative, but will they be right?

I fear by the second half of 2024, we could see clear signs of recession, and if so, I’ll be taking profits, hopefully near the top.