Recession or no recession? This question has been the focus of market discussion for most of the year coupled with the question of what the Fed will do about recession risk. The Chicago Fed does a good job of providing some exhaustive economic indices through their National Business Conditions Index and their National Activity Index. The Chicago Fed also provides leading and coincident indicators through their Brave-Butters-Kelley Indices (BBKI) monthly index. Tracking these indicator provides useful information but there are risks when using them as investment signals.
There has been very mixed signals between the BBKI leading and coincident indicators over the last 18 months that have added to investor confusion. By definition, the leading indicator should turn early relative to any turn in actual economic growth. The lead time is variable but can be at least six months or more. The leading indicator index turned up at the end of last year and has been on a strong ascent. The coincident indicator turned down just under two years ago and is now in negative territory.
Bond markets were discounting a recession for most of the summer. It is only in the last few months have some analysts turned slightly positive consistent with the BBKI leading indicator. There is the most risk and opportunity for investor when leading and coincident indicators are moving in opposite directions. The investor faces the risk of acting on leading information when the market may be focused on coincident information. Therefore, investors should spend extra care in timing trades and position risk when this occurs. Early action on the leading indicator would have lead to a switch from bonds to equity; however, current readings make this a more fruitful choice.
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