Every time the market corrects, pundits start looking for a recession. It’s not a crazy idea, since the S&P 500 is a leading indicator of the economy. Recessions are typically led by market corrections, but market corrections have also forecast ten of the last two recessions. The stock market alone is not a reliable indicator.
Those voting against the recession idea often cite the steep yield curve as a sign the economy is strong. (See, for example, here and here.) Recessions typically are preceded by an inverted yield curve, where short-term yields are higher than long-term yields, and we are far from that right now.
Those voting in favor of the recession point out a variety of weakening data series that often forecast recessions, especially new order indexes, credit spreads, and oil prices. (See, for example, here, here, here, and here.) Earnings and revenues are decelerating and that causes economists to fear for the future. Many indicators of this type are not actually negative yet, but the fear is that they will become so.
The truth is that no one knows what will happen.
You are right to be skeptical of economic forecasts. Most economists did not see the 2008 housing bust and recession coming—and on the other side of the coin, a few economists are still stubbornly clinging to their 2011 recession calls. The market corrected sharply, the economy slowed, but a recession was ultimately avoided as the economy picked back up.
Part of the rationale for the way we do tactical asset allocation is that we do not have to forecast—we change when the relative strength of asset classes or sectors changes. The biggest problem with forecasting is that people tend to have an opinion, which they proceed to back up by only looking at confirming evidence. Both bulls and bears can always point to signs of improvement or signs of deterioration. Trend following avoids that whole problem and just goes with the flow. As market expectations change, holdings in a relative strength portfolio change right along with them. Trend following is never ideal, but it’s mostly in the ballpark most of the time—and it’s way less stressful than worrying about the economy constantly.
