Evidence points to potentially challenging times
To slow or not to slow, that is the question. Investors in the U.S. seem to be once again struggling with the prospect of a recession in the American economy, with several warning signals flashing red.
The highest profile of these warning signals is also the one I am most tired of talking about. The indicator is known as an inverted yield curve, and it refers to the interest rates on cash and bonds. In a normal economic environment, the yield on shorter term bonds and cash is lower than the yield on bonds maturing many years into the future.
This of course makes logical sense, as borrowing someone else's capital for a longer period should be more expensive (higher yield) than borrowing for a shorter time frame. The yield curve inverts when investors believe longer term interest rates will move lower due to coming economic weakness and lower demand for capital in the future.
Although this indicator is not perfect, it has been fairly accurate at forecasting recessions. In the current economic cycle, the yield curve had been inverted since October 2022, only correcting itself after the Presidential election in December of 2024. Over the last month however, the yield on the benchmark 10-year U.S. Treasury bond has fallen off a cliff, going from 4.63% on February 11th to now around 4.1%. A move of this magnitude is quite dramatic and not to be ignored, but because the yield curve has been inverted for so long this indicator taken by itself seems like it could be less pertinent in this cycle. But other indicators are jumping on board as well, rattling investors and markets.
Another indicator of recession in past cycles has been crude oil prices. Over the past month the price of crude oil peaked at $73 also on February 11th, and is now priced around $67. While an 8% price move in this volatile commodity is not unusual, when considered with the move in bond yields, a pattern does seem to emerge.
Then of course, we have the stock market. While stock prices aren't necessarily the most reliable indicator of economic conditions, the signals sent by the stock market are considered a leading indicator on the economy and should not be ignored. The widely followed S&P 500 Index peaked at 6,144 on February 18th, and now sits about 6% lower around 5,800. Clearly, with three high profile financial market indicators moving in concert, investors are grappling with something, but what about the real economy -- does it offer any clues?
Well, last Friday cracks began to emerge in the economic data as well with weak numbers being released in retail sales and awful numbers in housing starts and existing home sales rattling investors. At the very least, it appears markets and the economy have hit a weak spot, begging the primary question, has the recession forecasted since 2022 finally arrived?
There is no doubt the American economy is entering a time of transition. The Trump administration is resolved to fulfill its perceived mandate to disrupt the status quo and is wasting no time getting to work. According to an analysis posted by Reuters, the Federal government is in the process of reducing employee head count by an expected 300,000 Federal employees, which according to the Brookings Institute is also expected to impact government contractors by as many as 700,000 people. While many of these workers will likely find new work quickly, some will not, and all of them are likely to file for unemployment. When in full effect, job losses at this level will move the needle on the unemployment rate, which could further support the idea of an economic slowdown.
Combine the layoffs with the general reduction in government spending being initiated by DOGE efforts, the soft patch in economic data from last month and the financial market warning signs, and an image begins to form -- one which may look a lot like a recession.
The technical definition of recession is two consecutive quarters of negative growth in economic output (GDP). First quarter advanced estimate GDP will not be reported until April 30th, but at this point I won't be surprised to see a negative first quarter report. Whether or not a full recession is experienced in the United States is still too early to say, but there is enough writing on the wall that it would be prudent to develop some strategies to help endure potentially more challenging times ahead.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
