5 clear signs that the economy is slowing down

While stocks continued to put together an impressive weekly winning streak that ended Tuesday with slight losses across the major indexes, it’s becoming increasingly clear that the US economy is slowing. My current view is that the country will be in at least a shallow recession no later than the first half of 2025. With the market selling at 22 times forward earnings on the S&P 500 and a price-to-sales ratio rarely if ever seen (among other evaluation). (such as price-to-book showing the same extreme valuations), investors are clearly not positioned for this potential economic scenario.

So today, we’re going to take a look at five signals that show key parts of the economy are clearly deteriorating.

Unemployment rate:

Let’s start with an obvious sign of the increase in economic constraint, the increase in the unemployment rate. The US unemployment rate has moved rapidly (from a historical perspective) from 3.5% last July to 4.3% in the July 2024 BLS report.

This movement triggered the so-called Sahm rule which has been breached before every recession since the 1950s. Investors will get another key data point on September 6, when the Bureau of Labor Statistics releases its jobs report for August. I personally hope Hurricane Beryl in July was one of the reasons only 114,000 positions were created (consensus was for 174,000) in July and we see a bounce back in August. NY Fed reported earlier this week, however, that “the share of people who said they were looking for a job in the past four weeks rose to 28.4%, the highest level since March 2014, and from 19.4% in July 2023.‘

GDP growth slowed substantially:

The federal government ran a fiscal deficit north of six percent of GDP in both fiscal year 2023 and, so far, fiscal year 2024 ($1.52 trillion for the first ten months of the government’s fiscal year). With the debt-to-GDP ratio already at the highest levels in US history, this is clearly unsustainable. Future administrations will either have to raise taxes and/or reduce spending growth rates. The tax cuts enacted in 2017 will also expire in 2025. Higher taxes and/or lower levels of spending will be drags on the economy at that time.

Keep an eye on how much the Government spends, because this is the real tax.” – Milton Friedman

It was one thing when all this taxpayer largesse drove significant economic growth, and GDP growth was north of four percent in the back half of 2023. However, that growth has slowed substantially here in 2024, with GDP growth of 1.4% in Q1 and an initial Q2 GDP estimate of 2.8%. Currently, the Conference Board only sees annual GDP growth of 0.6% in Q3 and 1.0% in Q4. The Atlanta Fed’s GDPNow calls for higher growth in the third quarter than the Conference Board’s, but that estimate was revised downward sharply a few days ago.

Main economic indicators:

Monday, US Leading Economic indicator or LEI have decreased for 28 of the last 29 months. This is another historical indicator that has had a solid record of predicting future recessions. The indicator had a clear gap this time. I suspect this is due to the trillions of dollars Congress has pumped into the economy with Covid stimulus programs and massive infrastructure spending packages.

The negative LEI reading this month was mainly caused by “a sharp deterioration in new orders, persistently weak consumer expectations of business conditions and construction permits, and lower hours worked in manufacturing drove the decline, along with the still negative yield spread.‘

More signs of consumer distress:

The low- and middle-income consumer has been under pressure throughout 2024, reflected in weak guidance in both the first and second quarters from the likes of Home Depot (HD), Starbucks (SBUX), Loews Corporation (LOW), McDonald’s Corporation (MCD), Macy’s (M), Nike (NKE) and a host of other well-known consumer-oriented names.

Recently, however, strong areas of consumer spending are beginning to show some cracks. Ecommerce sale in the second quarter they increased by only 1.3% compared to the previous quarter, after a 2.1% increase in the first quarter of this year. CNBC just posted one story on how demand for travel spending, which has been more than robust for over two years, appears to be easing.

Finally, the lowest mortgage rates in more than a year aren’t helping the housing sector yet. Housing starts escaped 16% on a year-over-year basis in July. Esales of existing homes It also had the weakest July since Redfin began tracking the measure in 2012. Housing affordability is still near historic lows outside the peak of the 2006 housing boom.

Yield curve:

The Treasury yield curve has been inverted consistently since early summer 2022. The last time the yield curve was inverted for this long was 1929. Let’s just say it didn’t end well for investors. In addition, the spread between the two-year and ten-year Treasury yields reached its highest level since 1981, when the US was in the midst of a brutal double-dip recession, in July 2023. This is another historically reliable indicator of a coming recession, whose “lag’ it has probably been significantly expanded by the excess trillions of dollars thrown at the economy by the administration and Congress in recent years.

However, the yield curve has started to flatten significantly in recent months. After peaking at just under 110 basis points in the summer of 2023, the spread between two- and ten-year Treasuries is currently less than 20 bps. They are likely to fully normalize before the end of the year as Chairman Powell begins to cut the Fed Funds rate, which is expected to begin at the FOMC meeting in September. The 10-year and 30-year Treasury yields have been normalized for some time.

Investors appear to be banking on interest rate cuts to reinvigorate the economy and further boost markets. However, rate cuts are unlikely to be the panacea they are hoping for. A recent drop of more than 1% in the average 30-year mortgage rate has done little to revitalize the housing sector to this point, after all.

Additionally, the onset of rate cuts has occurred particularly in the face of historic bear markets, especially when the economy is decelerating, as it is now. EDF it started to cut rates from near-identical levels in September 2007, just months before the Great Financial Crisis of 2008/2009.

The central bank also started cutting interest rates in early 2001, when the market was in the midst of the Internet crisis. The market did not bottom until the end of September 2022. From peak to trough, the NASDAQ lost over 80% of its value in this era.

You simply cannot raise rates the most in recent history at the fastest rate in recent history for the largest debt in history and not face consequences.” – ZeroHedge

I used the quote above from a ZeroHedge article earlier this month several times in recent articles. I think it surprises the complacency of the markets given the huge explosion of debt in recent years and the hopes of investors that we will get out of this difficult situation without paying the pepper. I just don’t think that’s going to happen, especially when the economy is clearly slowing down. Prudent investors should position their portfolios accordingly.