Are you ready for the next recession? The economy continues to expand and stocks are chugging along, but there are a few good reasons to prepare for a shift at a time when safety can be bought relatively easily.
The U.S. bond market is flashing an ominous signal that should raise concerns: The yield curve is flattening, which can mean that the outlook for economic growth is being revised downward.
Yields spiked higher early this year in anticipation of stronger U.S. economic growth under the new administration of President Donald Trump.
These moves are now reversing.
The yield on the 10-year U.S. Treasury bond has fallen close to 2.1 per cent, down from more than 2.6 per cent in March. That's near its lowest level since November.
As well, the spread between the 10-year and the two-year U.S. Treasury bond yields has narrowed to less than 78 basis points (or 0.78 percentage points), or the slimmest spread since September.
Translation: The bond market is expressing doubts about the economy.
The second reason for concern comes from the U.S. Federal Reserve.
The central bank has raised its key interest rate twice in 2017 and appears set on raising it again later this year as the labour market improves.
San Francisco Fed President John Williams, an alternate member of the Federal Open Market Committee – which sets rates – appeared to confirm this policy on Monday: "Gradually raising interest rates to bring monetary policy back to normal helps us keep the economy growing at a rate that can be sustained for a longer time," he said in a speech.
While that sounds like good news, inflation remains below the Fed's target rate of 2 per cent, feeding concerns among some observers that the central bank could be embarking upon a policy mistake.
Joachim Fels, global economic adviser at Pimco, argued in a recent blog post that higher rates give the Fed room to manoeuvre during the next recession.
"However, the risk is that by hiking rates too fast and too far, the Fed brings about exactly what it is so afraid of – the next recession," Mr. Fels said.
And third, consider the age of the current economic expansion: It's approaching eight years, or 96 months.
According to the National Bureau of Economic Research, U.S. expansions since the Second World War have lasted an average of 56 months, meaning that we are about 40 months above average.
Expansions don't die of old age, but the longevity of the current one should remind us that good times don't last forever. When they end, stocks get hurt.
Jonathan Golub, chief equity strategist at RBC Dominion Securities, noted that stock prices have fallen an average of 40 per cent during recessions since 1982.
Mr. Golub doesn't see a recession in the works. But he does point out that economically sensitive financials and small-cap stocks have lagged the market during the first half of 2017, after outperforming during the second half of 2016 when investors cheered the brighter economic outlook.
Perhaps today's darker signals will pass. It doesn't hurt to prepare for a shift, though.
Companies that perform well during recessions sell products and services that people continue to need when times are tough. Here are three ideas:
- BCE Inc. is a telecommunications company that provides Internet and cellphone services, which are probably among the last things anyone would give up. The stock has a 4.9 dividend yield, which means you’ll earn some income while waiting for a recession.
- Metro Inc. is a Canadian grocer, and food is not going anywhere. The stock has enjoyed a strong rally in recent years, but trades an attractive valuation of less than 18-times trailing profit. This stock did well during the financial crisis.
- Hydro One Ltd. is a Canadian electricity distributor that should cruise right through a recession. The shares have been stuck in a tight trading range because the Ontario government continues to sell down its stake in the utility, but that’s okay if you’re a buyer (full disclosure: I own shares).
Whatever you do, don't wait for economists to agree that a recession is coming. It'll be too late.
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