We introduced the Critical Signals Report Storm Tracker here as our starting point when it comes to assessing global risk and the proximity of the next recession. In Part 1, Part 2, Part 3, and Part 4, we’ve respectively looked at how trends, leading indicators, yield curves, and GDP inform our market signals.
Today, in Part 5 we’re going to examine our “surprise indicator.” You can think of it as a bonus tool that we call “déjà vu” – French for “we’ve seen this movie before” (roughly speaking).
Let’s Get Started
To understand the surprise indicator, we need to recap.
In Parts 1-4, we learned how trends, leading indicators, yield curves, and GDP together inform the Critical Signals Report Storm Tracker. These are forecasting tools – calculated using nearly 100 different variables. But that doesn’t necessarily mean the recession we are expecting has started… it’s just a forecast of when it will start – reliably so… but it’s still a forecast.
Enter the Déjà Vu Indicator
We’re calling the surprise indicator “the Déjà Vu Indicator.” The Déjà Vu Indicator may be complex to derive, but it’s simple to view.
The Déjà Vu Indicator concentrates on stocks vs. interest rates. In particular, it tracks the relationship between the stock market and interest-rate spreads. The word “spread” may seem confusing in this context, but it’s really quite simple.
The “rate spread” we are measuring with the Déjà Vu Indicator is the difference between the yield on the two-year U.S. Treasury and the yield on the 10-year U.S. Treasury. We then track the relationship between that “rate spread” and the S&P 500, thus calling this the “Déjà Vu Spread.”
When an economic cycle is at its peak, the Déjà Vu Spread (the green area on the chart below) widens out.
But when a recession approaches, the Déjà Vu Spread narrows, flatlines, and then goes negative. That’s when the indicator falls into the red zone, as per the chart.
As the Déjà Vu Spread widens, as it has recently, risks abate. When Déjà Vu narrows, that’s your signal to lookout below. As the Déjà Vu spread falls, risks rise and our Storm Tracker reading notches up, to help protect you.
We’ve seen a new, recent high in the Déjà Vu Spread (the green area above) and expect it will soon tumble, given a Storm Tracker reading of 45 knots and noting the speed with which the Storm Tracker’s reading has been increasing overall.
Pacing the next recession parallel to the recessions of 2001 and 2008, the Déjà Vu Indicator suggests we are on course for the next recession beginning in Q1 or Q2 2020.
But keep in mind that recessions are not officially called until we have two quarters of negative GDP behind us – and that wouldn’t occur until late 2020, even Q1 2021. But obviously, we don’t want to wait for an official recession announcement before acting.
By then, it would be too late. Instead, we prepare for the recession as it’s unfolding, not when it’s already confirmed by D.C.
Thus we track the Déjà Vu Indicator, which informs the Critical Signals Report Storm Tracker, which in turn informs the All-Weather Portfolio (to be shared soon) as to changes that may be required in asset allocation.
Summing Up Parts 1-5
Now that you’ve waded through all five parts of the Critical Signals Report Storm Tracker, let’s add things up in any effort to track landfall of the storm (i.e. the recession) ahead. Looking at each of the current, relative weights of the five indicators in relation to Storm Tracker, we are seeing that the components average out to 45 knots of recessionary wind speed… that’s pretty high.
This final indicator, Déjà Vu, combined with all prior indicators (i.e. trend, leading indicators, yield curves, and GDP indicators), shows a recession typhoon off the market’s bow.
Storm Tracker does not need to get to a wind speed of 100 knots before a recession hits, for when Storm Tracker gets to 100, you will have lost the lion’s share of any traditional investment. With Storm Tracker at 45 knots in May, it’s already time to take action – by going 45% to cash.
We’ll close this five-part series with these quotes from former Fed Chair Alan Greenspan, the so-called “maestro” of economic policy, just before the Great Recession…
- On January 10, 2008: “The Federal Reserve is not currently forecasting a recession.”
The Great Recession began in December 2007, one month earlier.
- On January 18, 2008: Speaking of Fannie Mae and Freddie Mac, “They will make it through the storm.”
Fannie Mae and Freddie Mac went broke and then were nationalized just two months later.
- On June 3, 2009: “The Federal Reserve will not monetize the debt.”
But that’s ALL the U.S. government has done since.
The Point Is This…
Nobody knows. Nobody has a crystal ball. The Fed’s “great experiment” (lowering interest rates, invoking massive QE, monetizing debt following the 2008 Great Recession) has an uncertain outcome.
Fed Chairs have little ultimate control. Nor do governments. Credit bubbles always precede recessions, and we are in one spectacular credit bubble at the moment.
In a worst-case scenario, the only desperate option our U.S. government has left is the dangerous policy of Modern Monetary Theory (MMT), which is effectively little more than massive money printing, debt expansion/can kicking, and a thoroughly stagnating America in which rising interest rates and inflation are presumed to be extinct forces.
Equipped with the right tools, like Storm Tracker and the All-Weather Portfolio, along with regular Critical Signals Report updates, you’ll be able to ride out this next storm and profit in any melt-up AND any melt-down by safe harboring a whole lot of cash to get back in when the time is right – i.e. at market bottoms, not market tops.
Our Next Five-Part Series
Thanks again for wading through this technically-oriented drill down on Storm Tracker. With this good an understanding of the myriad of indicators we are tracking for you, all you’ll need to follow is the Storm Tracker wind-speed number as it changes (with commentary) month-to-month.
As mentioned in Part 1, you’ve got to understand Storm Tracker to trust it, for it will inform you on allocations within the Critical Signals Report All-Weather Portfolio in our next five-part series.
Stay tuned. In the meantime, let those comments flow. We love feedback!
And be safe out there…