A $150 billion investment chief lays out his 4-part recession checklist - and warns we're approaching dangerous territory
- As calls for a US economic recession mount, it can be difficult to separate between the informed predictions and those that are simply piling on.
- In an exclusive interview with Business Insider, Brad McMillan - the chief investment officer of the $150 billion Commonwealth Financial Network - shared his four-part recession checklist for investors to watch.
- While the economy still has a ways to weaken, by the four measures outlined by McMillan, it's edging closer to troublesome territory.
As calls for an US recession mount, it's an easy time to pile on with vague platitudes about an impending economic meltdown.
Coming up with a detailed, multi-part recession scenario is another story entirely.
Brad McMillan, the chief investment officer of the $150 billion Commonwealth Financial Network, has done just that.
He's compiled a four-part checklist of indicators he watches closely for signs of an economic reckoning. And while none of them are flashing a warning signal at this very moment, they're edging ever-closer to troublesome territory.
The checklist ultimately provides a handy guide for investors to keep a close eye on the types of economic regressions that can trigger recessions, as well as the vicious market sell-offs that have historically accompanied them.
Here it is, broken down in detail:
1) Job growth drops below 2 million a year
For reference, the trailing 12-month sum of jobs added comes out to 2.2 million. So McMillan's threshold is somewhat near.
With that said, keep in mind that September 2017 - the last month included in the total - saw jobs contract by 33,000. Meanwhile, the September 2018 number is expected to mark an expansion of 184,000, so that trailing annual figure is about to look at lot stronger. Still, it's arguably the most important indicator to watch.
"If job growth were to pull back substantially, that would shake things," McMillan told Business Insider in an interview. "It reflects business confidence. If companies either aren't hiring or can't hire, that radically affects their ability to grow and expand. That's the one I would watch the closest."
2) Consumer confidence drops more than 20 points year-over-year
While McMillan keeps tabs on the overall level of consumer confidence - as measured by the Conference Board survey - he's far more interested in the directional trend.
He says that if the measure drops more than 20 points on a year-over-year basis, that's when a serious recessionary red flag would be raised. Considering that consumer confidence has been rising, and tends to fluctuate in small, several-point increments, this one would seem to have a ways to go.
For context, it rose five points to 138.4 in September, its third straight increase.
3) The ISM non-manufacturing index falls below the 50 threshold
At 59.8, the ISM non-manufacturing index is nearly 10 points from McMillan's holy threshold. The gauge hasn't slipped below 50 since August 2016, and was most recently below 50 for consecutive months in early 2016.
Still, it slipped by 1.5 points in September, showing signs of trending in a dangerous direction.
4) The 10-year/3-month yield curve inverts
The 10-year/2-year yield curve is the one most frequently cited by experts and the financial press alike. But McMillan favors the spread between 10-year Treasurys and their 3-month counterparts.
McMillan says this warning sign flashes red when inversion occurs - or when the 3-month yields more than the 10-year, signaling that near-term nervousness is at a fever pitch.
As you can see in the chart below, this relationship hasn't inverted quite yet, but it's the closest since the financial crisis a decade ago.
"From a financial perspective, the yield curve is probably the big one," said McMillan. "Everybody's watching it."
He continued: "If it were to suddenly invert, that would rattle Wall Street. If job growth suddenly fell off, that would rattle Main Street. If, for whatever reason, they both dropped off, everybody's going to be rattled, and that can't be good."
With the recession playbook established, one question remains: What about financial assets?
McMillan warns that a sharp sell-off will likely result once a recession strikes. After all, he says, everything from profit margins to buybacks to mergers and acquisitions have peaked recently.
McMillan's specific forecast is for a recession to strike in late 2019. So while we could have another six months or so of blissful conditions, things could quickly turn south after that. It's a similar forecast to the one recently laid out by billionaire investor Ray Dalio in an interview with Business Insider.
"I don't expect a severe recession, but we didn't have a severe one in 2000 either," said McMillan. "It was the financial markets that have the most correcting to do, not the real economy. And I think that's a very relevant comparison."