Flashing Orange Signal

December 13, 2018
Daniel Shainberg

Flashing Orange Indicator

According to PIMCO, the economy is “flashing orange,” signaling a recession is near.

The economic cycle does not work that way. There are no hard cut signs that the economy or markets will turn. Volatility can be an initial sign of a turn. So can the yield curve inversion, or a spike in credit defaults, or a widening of the TED spread, or rising unemployment, higher rates, and the list goes on. These economic statistics are backwards looking. To get a sense of the future, once has to understand where we are in the business cycle, the source of recent macro data and a sense as to whether that source can continue feeding the trend. 

In 2008 the statistics all looked great. Home prices were rising, new home starts were improving, oil prices were rising from what most perceived as healthy demand and unemployment was low. But what we now know is that the cause of that boom was artificially low interest rate policies set in place by the Greenspan Fed after 9/11. All of the apparently positive market data and statistical reporting on the economy thereafter were simply a reflection of that unsustainable policy. Once rates spiked, the market turned south quickly and the data changed. There was no single truism or “smoking gun” data point that we could have tracked to flash a sign that the crash was starting. It just doesn’t work that way.

PIMCO stated that “the chance of a U.S. downturn of 30% in the next 12 months is at a 9 year high.” This is nonsense. Pimco economist Joachim Fels and Andrew Balls, global fixed-income chief investment officer, wrote in an outlook, “the models are flashing orange rather than red.” They certainly might prove to be right but where does this 30% likelihood come from? Past examples? There are no perfect correlations to this decade long bull run of multiple rounds of QE. Add in the rise of Asia and related tariff threats plus technological advances. There is just no way to create a statistical model that can accurately input all of these real world situations and model out some color threat. It’s almost as ridiculous as the government’s color based threat list implemented after 9/11. Even they scrapped the use of that type of indicator.

In an instant we could hear news of softening rhetoric with regards to Chinese U.S. relations like we saw with North Korea. We could have the Fed announce a pause in their rate hiking trend, a prognostication that many Fed watchers believe is likely. We could see the benefits of the recent decline in oil prices follow through to consumer spending, the most impactful segment of the U.S. economy.

While this newsletter is dedicated to our bearish outlook for the markets, we will call out headlines such as the one in today’s PIMCO report that is clouded with eccentricity and unsubstantiated fear-based marketing.

Dan Shainberg

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