Recession in 2023 Confirmed?
In April 2022 I wrote an article called Yield Curve Inversion: Time to panic? as about six months ago the 2-year treasury yield was lower than the 10-year treasury yield once again.
In this article I already explained why I pay so much focus on the yield curve inversion:
The reason the bond market is considered to be “smarter” can be explained by looking at the past few decades. Not only was every recession since the 1970s preceded by a yield curve inversion, we also had almost no false signals. Only 1998 can be seen also a false signal when just looking at the 10-year treasury minus the 2-year treasury (blue line). However, the 10-year treasury minus the 3-months treasury (red line) did not invert before 2000 and predicted the recession quite accurately.
And while in April 2022 the 3-months treasury yield was still lower than the 10-year treasury yield the picture is now different and the 10-year treasury yield minus 3-months treasury yield is actually below zero (see red line in chart).
And as I have already written in my last article, this is one of the best early warning indicators for a recession out there. I have been cautious and bearish about the U.S. stock market before, but after the yield inversion I would see a recession in 2023 in the United States as highly likely.
Other Warning Signs
Aside from the inverted yield curve, there are several other indicators that might indicate a recession ahead of time and can be seen as early warning indicators. Let’s look at two of them in more detail: the ISM Purchasing Manager Index and the housing market.
Housing Market
When looking at the housing market we can especially pay attention to the new privately-owned housing units authorized in permit-issuing places. Big investments — and buying or building a privately-owned house is a huge investment for most people — are often postponed or cancelled when economic conditions get worse. Additionally, permits for building a house preceed the actual construction work and are therefore a great early warning indicator.
And when looking at the data of the last few months we can see a decline once again — it is not as steep as during past recessions, but numbers are getting worse from month to month.
ISM Purchasing Manager Index
Aside from the housing market we can also pay attention to the ISM Purchasing Manager Index. The explanation why this index can be an early warning indicator is also simple: Like housing permits, companies purchase less goods when they get first signs of demand slowing down and this is reflected in the purchasing manager index.
Usually numbers below 50 indicate trouble and a shrinking economy and the last reported number — in September 2022 — was 50.9. And especially the steep decline since 61 about a year ago is not a good sign.
Conclusion
We are getting more and more warning signs for the U.S. economy heading towards a recession in 2023 and to answer the question from the headline: Yes, when looking at the presented data, a recession in 2023 is a scenario with a high probability right now (and the recession might be six to twelve months away).
Of course, this does not rule out a potential bear market rally in the next few weeks (or probably months), but investors should now really be prepared for lower stock prices in the next few quarters. And unless it has already happened, it is time to reduce risk and exposure to speculative and cyclical asset classes.
