Midway through 2024, changes in our U.S. Recession Scorecard signal rising economic risks for equity investors in the second half of the year.
June 13, 2024
Jim Allworth Investment StrategistRBC Dominion Securities
Just two years ago, our Recession Scorecard was flashing nothing but green lights for the U.S. economy. That unequivocally unanimous rating began to deteriorate in the summer of 2022. First, in July 2022, the Treasury yield curve inverted when the 1-year Treasury yield rose above the 10-year yield, signaling that credit conditions were tightening in a serious way. Every recession in more than 100 years has been preceded by such a yield shift.
A couple of months later another of our seven indicators – the Conference Board’s Leading Economic Index – went red by falling below where it had been a year earlier. This has occurred before the onset of every U.S. recession since the late 1950s, or for as long as this indicator has been around. In the months that followed, three more Scorecard indicators shifted out of the positive green zone and into cautionary yellow territory.
Now, a third Scorecard indicator has been rerated to the recessionary red column: as of Q1, the growth rate of U.S. nominal GDP has fallen below the federal funds rate. Such a crossing point has occurred either before or just after the start of every recession going back to the 1950s.
* Potential change to Recessionary status pending.
Source – RBC Wealth Management
The notional economic linkage for this indicator is with categories of spending – primarily residential construction, business capital investment, and consumer spending on durables – for which the cost of borrowing is an important determinant. While not the largest component of GDP, at about 25 percent, spending on fixed assets and durables is highly cyclical. It is often a major contributing factor to recessions, usually going into outright decline under pressure from high interest rates, restricted availability of credit, and falling consumer demand.
One other Scorecard indicator – the unemployment rate – could be poised to flip into the red column, perhaps as early as next month. U.S. unemployment has risen in three of the past four months and now sits at 4.0 percent, its highest reading in almost two-and-a-half years. That has been enough to turn our trend-smoothing line for this data series upward for the first time since the onset of the COVID-19 pandemic.
As things stand, three of the seven indicators are rated “Recessionary,” and two are set at “Cautionary,” while two remain at “Expansionary” green. If the unemployment rate shifts to red next month, the count will become 4, 2, and 1. There is no score that makes a recession unquestionably inevitable. But even at today’s levels, the Scorecard portrays a decidedly different risk profile for the U.S. economy than the wall of green that prevailed in the decade following the global financial crisis and was restored within a few months of the short-lived pandemic-induced plunge.
U.S. recessions and equity bear markets in the developed world’s stock markets tend to go hand in hand. In our view, a redder tilt in our Scorecard should keep investors alert to a riskier, more challenging environment for equities that might arrive in the coming quarters.
The line chart shows the performance of four major equity indexes since December 1959: the S&P 500, S&P/TSX, MSCI Europe (since 1987), and FTSE All-Share. Performance is shown on a logarithmic scale, indexed to December 1959 = 100. Periods of U.S. economic recession are highlighted. All four indexes have followed similar generally rising paths, with periods of declining performance corresponding to recessions.
Shaded areas represent U.S. recessions.
Source – Standard & Poor’s, Toronto Stock Exchange, FactSet; quarterly data through 3/31/24, shown on a logarithmic scale, indexed to December 1959 = 100
This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.
The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.
Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.
We want to talk about your financial future.