M&G's Leaviss: 3 Warning Signs of Imminent US Recession

Investors should not be surprised if the US slips into a recession, says M&G's Jim Leaviss, with a number of warning lights now flashing red

David Brenchley 29 November, 2018 | 7:36AM
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Housing market, US housing market, mortgage rates, US economy, recession

A number of warning lights are flashing red and investors should not be surprised if the US falls into recession next year, warns Jim Leaviss at M&G.

There are plenty of measures pointing to a downturns, says Leaviss, manager of the Morningstar Silver Rated M&G Global Macro Bond fund.

One of those is the yield curve; economists often cite the difference between the yield on two-year and 10-year US Treasuries as an accurate gage of the economic cycle. The curve continues to trend towards inversion – when the two-year bond yields more than the 10-year bond – which is considered the number one pre-cursor of a recession.

Investors are divided as to whether the yield curve inversion is indeed signalling a recession this time around - but another measure is concerning Leaviss.

That is the US housing market, which went a long way to causing the great financial crisis of 2007-2008.

Interest rates in the US are well on their way to normalisation, with eight hikes since 2015 taking rates to their highest level in more than a decade at 2%-2.25%. This is already having an impact on the real economy, says Leaviss.

Housing Market Weakness

US mortgage rates, for example, are now running at seven-year highs. At the same time, the monthly supply of houses in the US ratio currently stands at seven, a level not seen since early 2011 and very much on an upward trend.

This measure means that, if no additional new houses were built, it would take seven months for the current inventory of houses for sale to be sold.

This is troubling for Leaviss because it tends to be a leading indicator of a recession. “Traditionally when you get through seven months’ unsold supply, you get a recession in the US,” he explains.

The reason for this is because strong housing activity tends to have a “powerful multiplier effect”. That’s because when consumers buy a house, they also purchase big-ticket items such as carpets, televisions, white goods and furniture.

In the US, car sales are also highly correlated with property purchases; many Americans move from an inner-city flat to a house in the suburbs, and so need transportation.

“Housing has a huge impact on the economy,” says Leaviss. “A bit less than it did as a share of GDP back in 2007, but back in 2007 this was a very strong signal that the US was heading towards a recession.

“Even though the market was pricing in 3%-plus economic growth for 2007/08, the housing inventory itself showed that probably you were going to get a recession.”

New Car Sales Continue to Fall

We see a similar pattern emerging with car sales. Sales of automotive have been falling for the last couple of years, and some more recent issues look to extend that trend.

In the US specifically, car sales fell 8% from 2015 to 2016 and 10% from 2016 to 2017. And Leaviss says at a global level, car sales are falling by around 10% per year, something we last saw in 2008.

This week General Motors (GM) announced plans to stop production at three factories in North America and lay off around 18,000 staff. In Europe, meanwhile, we’ve seen a scandal around diesel cars leading to more stringent emissions standards for new vehicles. And tariffs are also taking their toll, with Tesla recently reporting a 70% drop in Chinese sales for October alone.

Meanwhile, debt continues to rise, be it Government debt, corporate debt or household debt. All three are running at higher levels than they were before the financial crisis thanks to years of rock bottom interest rates.

Of course, as that pattern of low rates continues to reverse, those sovereigns, companies and consumers will find it harder to pay off the debts they have built up.

The result of this, Leaviss predicts, is a ceiling on just how high rates can go: “It’s going to be a really difficult to hike rates without causing another accident in the global economy.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
General Motors Co32.36 USD2.41Rating
M&G Global Macro Bond GBP I Acc144.52 GBP-0.30Rating

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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