Economic Outlook:
Is the US About to Slip into a Recession? Dr Constantin Gurdgiev In almost every sharp downshift in economic activity, and more frequently than that, in almost every economic recession, there are several regular predictors or leading indicators of tougher times ahead. These include sharp drops in corporate profits, and acceleration in yields on lower rated corporate bonds, usually followed by significant declines in industrial production indices and subsequent downward corrections in stock markets and services activities indices.
CHART 1: Non-Financial Corporate Profits and Nominal GDP Growth Rates, Percent per annum
While these sequences of events repeat with regularity, in many cases, forward signals of recessions can involve a slight variation in timing and permutations of these shocks. Another regularity that happens when it comes to business cycles is that, traditionally, the US leads Europe into the downturn. Trouble is, judging by all factors mentioned above, the US is currently heading into a recession. Fast. And with some vengeance. Source: Author's own calculations based on data from the Federal Reserve Bank
Chart above shows clear pattern of correlation between corporate profits growth rates and subsequent growth rate in nominal GDP. It also shows that US corporate profits growth rates have been on a declining trend since 3Q 2010.
The Bad News Let’s start with corporate profits. The latest data from the US Federal Reserve shows that year-on-year 3Q 2015 growth in corporate profits for non-financial corporations was sharply negative - at -4.26 percent. Furthermore, corporate profits growth slowed down from 7.72 percent in 1Q 2015 to 1.83 percent in 2Q 2015. The rate of decline in corporate profits growth in the US is now sharper than during the last GDP wobble in 1Q 2014 and sharper than in 3Q 2008. The latest growth figure also marks the fastest rate of decline in profits since 3Q 2009.
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Meanwhile, corporate debt yields are shooting straight up. Added to this dynamic is another troublesome sign: yields volatility is also on the rise. In other words, the markets are not only nervous about individual issuers, but are appearing to be scared of the entire asset class. I wrote about this phenomena in previous newsletter, here. Behaviourally, international and US investors have been running for the hills for some time now, despite the extremely risk-supportive monetary policies not just by the Fed, but also by major carry trade-sustaining central banks (Bank of Japan and ECB). In normal conditions, carry trade drivers should moderate risk aversion effects. Except they are not doing so today. As noted in a recent research note by J.P. Morgan Cazenove in general, credit spreads lead equities and the former “are not giving a positive signal� to the latter (see: http://trueeconomics.blogspot.com/2016/01/24116-high-yield-bonds-flash-red-for.html). So that puts two recession-beaconing stars into a perfect alignment. What about the US Industrial Production? From over 2015, US industrial output posted declines, based on monthly growth rates,