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Recession Predictors Point to Expanding Economy
By Mel Miller

This is the first in a series of economic updates that will focus on key economic indicators.

During college I became fascinated studying the economy and the markets. My interest only intensified during my forty-year career. I would like to say that I have finally got all the answers, but, unfortunately, I don’t. When it comes to predicting recessions there is no one “perfect” indicator, all have failed on occasion… yet the quest continues. Given the caveats, I would like to share one of my favorite recession predictors.

Business cycle predictors are invaluable when it comes to eliminating economic “noise.” Tracking the trend of credit spreads provides a glimpse into the future. Just as canaries are used in mining to identify risk to miners (air quality), monitoring the direction of high-yield bond yields compared to yields on comparable duration treasury bonds is a time-tested method of measuring macro-risk.

During periods of economic growth the spreads tend to narrow as investors’confidence levels increase, driving down the spread on “junk” bonds compared to “safe” treasury bonds. This is called “risk on”—investors are generally willing to purchase risky assets. When investors begin to lose confidence in the economy, they seek to reduce risk—this phenomenon is often referred to as “risk off.”

Monitoring the spread between the Baa corporate bond index vs. the treasury index provides a real-time estimate of investor sentiment. It provides a more reliable look at the attitudes of investors and consumers because it does not rely on surveys; rather, actual financial transactions.

What is the current status of this predictor? Spreads have been declining since the peak reached December 16, 2008. In fact, the difference between the junk bond index and the 10 year treasury index has declined from 622 basis points (6.22%) to approximately 250 basis points (2.50%). The low point reached prior to the Great Recession was only 149 basis points (1.49%).

The trend is definitely positive and points to increasing confidence and an expanding economy.

First Affirmative understands that the ways we save, spend, and invest can dramatically influence both the fabric and consciousness of society. We believe that in addition to the benefits of ownership, investors bear responsibility for the impact our money has in the world. Are you making conscious decisions about the impact of your consumer purchase and investment decisions?

NOTE: Indexes are unmanaged groups of securities and are not directly available for investment.

Posted: December 2, 2013