Recession 2020? Our Salvation?

The last five recessions are shown in vertical gray bars on this chart comparing the 10-year treasury yield to the 2-year yield.  As you can see, the yield as slowly worked its way back into negative territory once again, after a very long bull run.

Stock markets were shaken August 14 by the fact that the 10-year yield on US Treasuries briefly turned lower than the 2-year yield.  I say "briefly" because it was an intraday reading.  By the close of the day the 10-year was higher, albeit by the thinnest of margins.  I learned long ago from the late, great Richard Russell to discount most intraday action where markets are concerned (unless you are a day-trader, which I am not).  It is the action at the close of the day that really counts.

When the longer term treasury yields less than the shorter term one it is called an "inverted yield curve" (the first since 2007).  The 10-year vs. the 3-month treasury yield actually inverted back on May 15 without significant market reaction.  It remains negative today.  Comparing treasury yields has been a reliable predictor of the past five recessions.  

But, for whatever reason, the 10-year versus the 2-year holds more weight.  The markets know this and reacted negatively on the intraday action, but they rallied from that 800-point loss over several days until Trump's trade war with China sent the already weak market down over 600-points on August 23, despite Federal Reserve Chairman Powell indicating that the Fed would consider an interest rate cut in September.

Trump said the Fed chairman is "the enemy" of our economy after Powell suggested that Trump's trade policy toward China is creating "turbulence."  The Fed has a long history of understating things and this episode was no exception.  Trump's sensitivity to reality shows how desperate he is to heap blame for the darkening skies over our economy upon others after taking personal credit for everything for so long.

Almost a year ago, I wrote about watching the 10/2 Treasury indicator ever since this bull market became the longest running in history.

With the Dow Industrials down 800 points on August 14, talk of a "recession" became more commonplace.  A wicked soup of Trump's trade wars, slowdowns in both Germany and China, among other factors combined to dim the prospects of continued global economic growth.  At the time, Forbes flat-out said "you should sell your stocks."  Was that an overreaction?  

Today the 10/2 yield finally turned negative at the close (the comparison is at -.048% as of 4PM today).  This was enough to send the Dow, which was positive for most of the day, down over 120 points when the closing bell rang.  This means that, most likely, a recession is in our near future.  But even without that action there is another reason for concern beyond the yield curve and the trade war.  I'll get to that in a moment. 

The treasury yield comparison is officially maintained by the Federal Reserve Bank of St. Louis and can be seen here.  This is what it tells us historically...

On August 18, 1978 the 10/2 yield curve turned negative.  The US entered a recession January 2, 1980 - about 16 and a half months later.

That recession was a short one, lasting until June 30, 1980.  But the yield quickly went negative again on September 12, 1980.  On June 30, 1981, exactly one year after the previous recession ended, we re-entered another one.  This one occurred about 9 and half months after the treasury signal.

The yield curve did not invert again until December 13, 1988.  The next recession began on July 2, 1990 - some 17 months later. 

An inversion occurred again on February 2, 2000.  The US entered recession on March 1, 2001 - about 13 months later.

On February 2, 2006, another inversion happened.  This led to the Great Recession, which officially began December 3, 2007 - a difference of about 22 months.

You can't really compare one recession with another.  They are all different in terms of their causes and their severity.  (Little of this has any to do with who is president, by the way.) But, taken together, we can say that once the yield curve inverts, a recession follows, on average, within about 15 and half months since 1978.

So, with today's close, it is not unreasonable to conclude that by the time of the general election in November 2020, the US will either already be in a recession or will be on the verge of one.  Either way, the economic growth we have seen in the past few years will gradually fade between now and then.  

That is bad news for President Trump, though it won't defeat him by itself.  Still, outside of his rapid partisan base, the rest of us know the only thing he really has going for him is a roaring bull market.  Oh, he will doubtless blame the Federal Reserve for this as well as anyone else he can make up a convincing lie about.  But these treasuries are not controlled by any specific policy.  They are controlled by the multitude of factors that create economic cycles.  

Trump will have his recession no matter what he or anyone else does simply because Bull markets give way to Bear markets give way to Bull markets.  It is the ebb and flow of modern capitalism, not the design of anyone.

Even without the inverted yield curve, however, good ole reliable Dow Theory has been offering a cautionary tale.  The Dow Transportation Average has never confirmed the recent all-time high by the Dow Industrial Average.  That non-confirmation is usually a signal for caution in stocks.  Combined with the treasury action, this helps validate the fact we are in "uncertain" times, as Fed Chair Powell put it recently.

The Dow Industrials have reached all-time highs in recent months.  But...

Compare the performance for the last 3 years in the Dow Industrial Average (above) with the Dow Transportation Average (below).  Clearly, though the Dow has reached new heights in recent weeks, the Transports have refused to follow.  This sets up a Dow Theory non-confirmation.  Caution is urged, the future of the bull market is in question.

My bet is on a pre-recession business cycle slow down in 2020 with a full recession in 2021.  (Again, it does not matter who is president in 2021.)  Let's see who Trump blames for this rather natural economic occurrence, especially in light that he has taken all the credit for the late-Bull rally (begun for several years while Obama was in office) since he was sworn-in.  By tying himself so personally with the market's performance, Trump is now in a position to reap what he has sowed - his market will go down, his economy will turn sour.

If the Democrats manage to keep it real and nominate a moderate candidate, any moderate candidate, they will give Trump more than he can handle in the general election next November.  If, however, they offer a candidate that is too "progressive" or one that allows Trump to scream "socialist!" it's anybody's ballgame.  

I'm banking on Democratic moderation in the face of a new recession to rid us of train-wreck Trump.  Am I hoping for too much?  Probably.

Either way, a recession shall now cometh.  Let's see how long it takes and to what extent it might influence voting next November.