When AIER updated its Business-Cycle Conditions model last year, we updated our leading indicators. Based on statistical analysis, we added to the new model the spread between the U.S. 10-year Treasury note and the one-year Treasury bill. Using the 10-year note seemed logical since it is the most liquid, and the 10-year maturity is considered a benchmark across most developed-economy, sovereign-debt issuers. The choice of the one-year bill was supported statistically but also seemed to have intuitive appeal, since it closely mimics or is slightly ahead of the moves of the federal funds rate.
As of the most recent model update, the yield curve indicator in our Leaders index gave a positive signal, meaning a recession is unlikely. By looking at the individual inputs of the indicator, however, we can make some interesting observations. First, over the past three-and-a-half decades, yields have trended lower. That’s not surprising if for no other reason than consumer prices have been in a broad disinflation trend—that is, the pace of price increases has been slowing since 1980.
The second observation is that yields on both the 10-year note and the one-year bill tend to move in the same general direction around economic cycles, although the one-year bill yield tends to move relatively more because it anticipates Fed interest rate cuts and increases in response to economic conditions.
Looking at recent performance, the yield on the 10-year Treasury note has fallen in recent months but no more dramatically than the drop in 2012 to historic lows, and it has not fallen past those levels even as it has remained below 2 percent since late January. Even more interesting, the one-year bill yield moved higher in 2015 in anticipation of the Fed’s first rate hike, which was implemented in December 2015. But it has not begun to move lower, indicating that the market is not anticipating any rate cut by the Fed (Chart 5).
Even though food is a necessity that would seem to be independent of the business cycle, commodity prices for food products like wheat, corn, beef, milk, and rice move similarly to other commodities, so consumer food product prices tend to be somewhat cyclical.
During the 1980s and 1990s, commodity prices tended to be volatile and somewhat cyclical but stayed in a general sideways trend, finishing 2001 below the level seen in 1982. After 2001, a major bull market developed for most commodities that lasted into the 2008 –2009 recession, when prices collapsed. After the recession prices rebounded and generally moved higher through 2010, then began trending lower. That decline continues today (Chart 6).
Those slumping food commodity prices have contributed significantly to a drop in many consumer food prices. If the historical patterns hold, prices for food purchased for consumption at home (i.e., grocery store purchases) are likely to remain very soft (Chart 7).
For most equity investors, 2016 has been a challenging environment so far. U.S. stocks fell sharply during the early part of the first quarter only to rebound in the latter part. Most broad U.S. indexes showed slight gains for the year through April 1. However, many of those indexes remain 2 percent to 8 percent below their all-time highs.
In our BCC model, we use real equity prices, meaning that they have been adjusted for inflation. These prices have been trending lower for eight consecutive months. It is worthwhile to note that the model only reflects data through February 2016 and that much of the rebound in equities occurred in March.
It is also worthwhile to put recent performance into a longer-term perspective. Over the past 65 years or so, the Standard & Poor’s 500 index of U.S. equities has risen an average of about 7 percent a year, though there have been significant deviations along the way. For example, using monthly averages, the S&P 500 first exceeded 100 in September 1968 and moved above that for the last time in June 1979, almost no change over a decade.
There were, of course, a number of business and market cycles before, during, and after that period. Depending on how they are defined, there have been approximately 14 significant market cycles or market declines since 1950—most of which, but not all, coincided with a business cycle.
Meanwhile, the current decline from the peak for the S&P 500 stands at about 1.6 percent using monthly averages. So while the real stock price indicator in our BCC model is signaling a potential recession, the magnitude of the decline using monthly average nominal stock prices remains quite modest by long-term historical measures (Chart 8).
If the difficult first quarter for U.S. equities added to concerns about a potential U.S. recession, then the performance of equity markets outside the U.S. could be downright alarming. As noted, the real U.S. stock price index in our BCC model has been trending lower for eight months, not including March. On a nominal basis, stock prices in the U.S. have rebounded significantly, leaving them just below prior all-time peaks. That suggests that the signal from the model could revert to neutral if this performance continues.
When the overall performance of the S&P 500 is compared with global equity indexes that exclude the U.S., a less comforting picture emerges. Developed markets outside the U.S. and emerging market indexes logged positive performances in March, but in both cases, the latest data points remain significantly below prior peaks.
We do not have BCC models for other countries or regions (yet). But if we assume that global equity markets are likely to be valuable indicators for business cycle turning points outside the U.S., then despite the better performance by these indexes in the latest month, the recent trend would still be lower. This suggests an elevated risk of a recession or at least further slowing in global growth during the months ahead (Chart 9).