2016 certainly opened with a bang. It started with a massive sell-off in the Chinese market that sent ripples throughout the world. Oil and other commodities continued to plumb new lows. Treasury yields dropped and volatility increased. The combined impact of these events led to an increase in bearish calls for the US economy, which is bolstered by the drop in the Atlanta Fed’s GDP Now and Moody’s High Frequency GDP models. In this article, I’ll take a look at the long-leading, leading and coincident indicators, which will show some weakness exists. But, so far, that weakness is contained within the manufacturing sector, and is caused by the strong dollar, weak oil and weakening emerging economies. In contrast, the US consumer continues to spend on big-ticket items. So long as this behavior continues, we should see at worst, a slight contraction lasting a quarter or two.  

The Long Leading Indicators

There are four long-leading indicators: two (corporate profits and Baa bond yields) are showing some weakness but not contraction while the other two (building permits and M2 Y/Y growth are still positive.

Corporate Earnings

The two charts above contains two data sets: corporate profits after tax with inventory and capital consumption adjustments (in blue) and corporate profits after tax without inventory and capital consumption (in red). The top chart shows the data for the last five years while the bottom shows the last 25 years. Unadjusted numbers increased slightly over the last year while adjusted earnings have not meaningfully increased since approximately 3Q11. Regardless, neither is moving lower yet, which the lower chart shows is required for this data to point towards a recession. 

 BAA Bond Yields

The top chart shows Baa yields while the bottom (from Scott Grannis) shows not only the entire high yield bond market’s yield, but also the yields for high-yield energy companies. Although many people argue the large increase in junk bond yields will lead to a recession, the bottom chart shows that, so far, the risk is contained within one sector. Additionally, the top chart demonstrates that while the BAA market – which is a bit less risky than junk bonds – has widened a bit, it’s nowhere near recessionary levels. Combined, the two charts denote a market under some stress, but largely due to the impact of one market area (energy).