Recessions don’t come on a schedule, but most times there are some warning signs one is on the horizon.
By looking at current macroeconomic trends, Savita Subramanian at Bank of America Merrill Lynch extrapolated an estimate of the timing of the next recession.
“But in examining some of some of our favourite indicators’ recent trends, we did find evidence for an imminent recession,” wrote the BAML equity strategist in a note to clients on Wednesday. “While the range of signals is wide, in aggregate they do suggest that, if data were to continue to weaken in line with the recent pace, history would point to a recession in the second half of 2017.”
Subramanian looked at five main macro factors to determine what they are saying about a recession: The 2-year Treasury yield vs. the 10-year yield, the ISM manufacturing index, building permits, temporary help job growth, and commercial and industrial loan growth.
By looking at what each of these indicators did prior to previous recessions over the life of the indicator, Subramanian was able to come up with an estimate of we are in the business cycle.
“In this scenario, the range of potential recession start dates implied by these models was as early as July 2016 and as far off as April 2019, with an average start date of October 2017,” wrote Subramanian.
On the other side Subramanian mentions that some macro indicators like consumer confidence and initial jobless claims would indicate that a recession is far off. Plus, BAML’s economics team does not expect a recession over the next 12 months.
Despite this Subramanian said investors should be careful for any sign of a downturn, as stocks typically fall off well before the start of a recession.
In terms of investment, however, Subramanian notes there is little feeling of the “euphoria” that usually presages a recession. Cash levels for investors are still at incredibly high levels, indicating the top may not be in. Subramanian said that people shouldn’t take too much solace in this fact.
“Large cap active managers have the highest cyclical exposure since 2012 and their overall beta exposure is near cycle highs,” said the note.
“Meanwhile, equity funds (mostly passive) have seen over $100bn more inflows over the last five years than during the same period ahead of the 2007 market peak. We also estimate that US household equity exposure has risen to levels similar to where markets peaked in 2007.”
Despite this, Subramanian said that missing the end of a bull market and selling too early is worse for overall returns than being invested during a bear market. Thus, despite the worry, it is better to stick to your guns.