by Thomas Wash
The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. We have created this report to keep our readers apprised of the potential for recession, which we plan to update on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.
January saw broad improvement in the economic data. The signing of the “Phase One” trade deal offered reassurance that the impact of the trade war would be limited in 2020. Several sentiment indicators surged, likely in response to the development. The NFIB Small Business Optimism Index, Chicago National Activity Index, Philly Manufacturing Outlook and Consumer Confidence, which is featured in the diffusion index, all improved during the month. In addition, financial markets offered mixed signals about the resiliency of the economic expansion due to growing uncertainty about the global economy. Conflict between the U.S. and Iran following the death of Qassem Soleimani and the COVID-19 outbreak in China reignited fears of the U.S. economy’s exposure to geopolitical risks. As a result, there was a slight deterioration in the gains made in equities and flattening along certain areas of the yield curve. Nevertheless, positive gains in employment and improvement in manufacturing activity suggests the economy remains strong. Our diffusion index has improved from the previous month with nine out of 11 indicators in expansion territory. The reading for January rose to +0.636 from +0.576.
The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is headed toward a recovery. On average, the diffusion index is currently providing about six months of lead time for a contraction and five months of lead time for a recovery. Continue reading for a more in-depth understanding of how the indicators are performing and refer to our Glossary of Charts at the back of this report for a description of each chart and what it measures. A chart title listed in red indicates that indicator is signaling recession.