RSM recently entered into a strategic partnership with the UCLA Anderson Forecast, a longstanding and well-respected barometer of the economies of California and the United States issued by UCLA Anderson School of Management, based on GDP data and other economic indicators.
Earlier in June, the Anderson School put on a conference that featured a presentation by Edward Leamer, an Anderson professor of economics and statistics, entitled “Looking for Recession Precursors among the Contributions to GDP Growth.” Leamer finds that the bond market yield curve, reduced household consumption and residential investment, combined with an environment of slow growth, can together signal the advent of a recession.
The primary takeaway is that UCLA’s “3, 2, 1” forecast, which calls for growth of 3% in 2018, 2.1% in 2019 and 1.4% in 2020, remains on track. Even with the projected growth for this year and next, Leamer’s recession probability estimate implies rising risk of a recession in 2020.
Leamer offers a roadmap for anticipating the end of economic expansions, concluding that:
- the yield curve is important;
- “negative durables and nondurables and consumption and weak services” warn of the end of an expansion;
- “weak GDP growth does occur near” the end of an expansion;
- we should pay attention to residential investment;
- exports and imports are not good predictors of recessions;
- government spending is not a good predictor; and
- the age of an expansion is a “suspicious” variable.
Leamer’s analysis suggests that the big news is that the bond market emerges as an important part of a recession alarm, reflected in an inverted yield curve. But that’s Wall Street speaking. Main Street’s contributions to the recession warning include weak investment in intellectual property, increases in the rate of inventory investment, strong exports and declining imports (which make the contribution of imports positive), and that each additional month of expansion subtracts “27% of a quarter from the expected life “ of that expansion.
Leamer suggests that the 3.1% growth in the first quarter is “not cause for celebration” and policymakers and investors should pay attention to the 1.2% increase in real final private demand which is a better proxy for business conditions in the real economy. Rather, Leamer’s models suggest 5.5 or 8.4 quarters of growth remaining in the current expansion, depending on the inclusion of an age variable, or duration of the economic expansion, in the model. Thus, there is a 50% probability of recession in 2020 or 2021. Our own RSM recession probability model implies that once the probability rises above 50% there is a strong likelihood of a recession within the next 12 months. We will update the model once all data for the second quarter of 2019 is collected.
