Coronavirus & The 6th Recession Red Flag?

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First and foremost, the 10-year yield is at 1.37% currently.

What I wrote on February 3rd for HousingWire talked about how the bond market can head lower back then if the headlines get worse. Also, in this article, I talked about how, even in this record-breaking expansion, we have had 3 quarters of negative GDP. To add another data line to the mix, we have had 4 other times were GDP was below 1%. None of these times was the U.S. ever going into recession.

In chaos theory, the butterfly effect refers to the idea that due to the interconnectedness of all things, a small event can result in large effects on a nonlinear, dynamic system.  

The butterfly effect gets its name from the metaphor that even small swirls of air caused by the flapping of a butterfly’s wings can change the path of a tornado, even though the system is far removed in space and time from the initial event. 

In many ways, we see this theory manifest in the U.S. bond and stock market – a dynamic system that is prone to the influences of distant perturbations.

Case in point, a virus outbreak among an urban population of a distant country may lead to a lower rate of growth in the economy in 2020. But it could also lead to a lower 10-year yield and thus lower mortgage rates for the housing market.

From Boeing to Brexit: 7 major storylines that could send mortgage rates even lower

This is the 4th time in this record-breaking expansion that the 10-year yield has gotten below 1.60%. Whenever this happens, the recession fly boys come out talking their usual doom and gloom. Let me address some concerns with my recession flag model. One thing that is different now was that back in 2012, 2016, and 2019 when the 10-year yield got to these levels, those events, Spanish Default Fear Trade, Brexit, Inverted Yield Curve/ Trade war, those things we could get a grasp on economically. The Coronavirus is still unclear to us on the duration and scale of the economic impact. It’s not shocking that the 10-year yield is at 1.37% today.

In fact, this was a theme of mine for my 2020 forecast, and this was before the Coronavirus.

2020 Economic& Housing Forecast 

https://loganmohtashami.com/2019/12/28/2020-economic-housing-forecast/

“Any stock market sell-off, correction, or near-bear market can drive money into bonds short term. With many headline-driven risks in play next year, don’t ignore the lower end of my bond market channel just yet. If growth picks up, even just a tad next year, then I don’t expect we will stay under the 1.60% level too long if we see headline risk. This has been the reality in this record-breaking expansion; short-term headline-driven events take us below 1.60% on the 10-year yield. However, we don’t stay there too long because we were never going into recession. Slowing growth took yields lower, but slower growth doesn’t necessarily mean an imminent recession. The failure to understand this has been a plague for the American Recession Bears.”

For those who don’t know what I am talking about, I have stressed for many years that the American bears (Mostly Gold Bugs and Stock Traders) don’t have economic models to call for recessions.  I have 6 recession flag model, and only 3 of them have been raised.

2 of the recession flags data lines have gotten better as housing starts, and leading economic indicators are looking fine today. Housing permits just hit a cycle high, and the leading economic indicator last week had an uptick breaking the slow-moving downtrend we had recently.

The model can be found here, updated February 13th, so last week’s positive data not included.

https://loganmohtashami.com/2020/02/13/recession-red-flag-update-2020/

6th recession red flag is:

 An over-investment in the economic cycle creates a big supply spike due to weaker demand, which will drag the entire economy lower.

I often joked that the Anti Central Bank Gold Bugs need a plague and virus outbreak to get their supply shock due to a demand hit because their theories of recession have never come true. After all, demand is still growing.

Literally, we have an outbreak virus that is crushing the Chinese economy, and now the infection has spread to other counties, South Korea, Italy, and Iran.

The U.S. economy itself was doing fine pre Coronavirus, we don’t have a significant over-investment sector that will be crushed quickly that will lead us to a recession in a short time.

However, specific sectors will be impacted due to a lack of demand from this virus.

Tourism, airlines, and cruise ships will lose revenue. Oil prices will head lower as growth is hit, especially if no production cuts happen.

The dollar will stay strong, and demand from overseas for some of our goods will be hit, so trade will take a short term hit. In fact, look for that 3rd government bailout for farmers to happen as Phase 1 deal goals won’t be met.

The recent uptrend in PMI and ISM probably can’t be sustained in the future, and that data line should get hit. Philly, Richmond, Texas PMI data, and ISM were all showing a positive print recently.

My best advice is to look at the information coming out one day at a time rather than do what the Gold Bugs are doing today, focusing on the worst-case.

Duration and scale matter at this stage.

So far, this virus has not caused any city shutdowns in America, that is a huge deal, if that happened, the 10-year yield would easily be under 1%. A concern I have of mine is that I hope we aren’t rushing people back to work for the sake of economics. Safety should come first.

Be the detective, not the troll, for some of you, this is your first virus outbreak working with economic data.

The one benefit we have here in America is that a lot of economic data has gotten better recently, so we can weather the storm better than most. Also, the Boeing situation looks like for now, it should be resolved by the 2nd half of 2020.

A reflection point:

The unsung hero of 2019 ( The Inverted Yield Curve) is the unsung hero for 2020 as well.

I truly believed that the inverted yield curve of 2019 forced the President to cut a deal with China for these reasons.

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A lot of people were afraid of the trade war escalating with higher tariffs %, and who knows what else could have happened. Back then, I was so confident that this sealed the deal, that I stated it would be a bullish event.

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Article here: 

https://loganmohtashami.com/2019/08/14/my-inversion-forecast-techincally-met-and-this-can-be-bullish-for-the-economy/

Imagine a higher tariff % and no deal running into this event! One thing about this event is that for now, the President won’t rattle the tariff war toward China or Europe while this virus is still in the headlines.  Personally, I never believed in the trade war, calling it a tap dance, but the market was concerned about it. Also, growth did slow down in 2019. In fact, let’s not forget that gross private domestic investment did not happen in the last 3 quarters, this is rare in our expansion, it only happened once back in 2015/2016 with the first PMI recession.

The republicans on CNBC were right about this.

” How could companies make long term investment decisions if they don’t know what government policies are”

Now, a deal was cut, and we were on a better path until this Coronavirus happened to join the Boeing delays. Also, Nafta 2.0, which is really important, got done recently.

Q4 GDP 1st 2019

For now, know that this is the only thing that the American recession bears have going for them. The Boeing situation can only impact growth, and it was going to get fixed. Without the Coronavirus, the bears have nothing.

Take it one day at a time, show discipline here, don’t fall prey to the drama bears people, and don’t assume this has a mild impact either.

Be the Detective, not the troll. 

One final point!

The St. Louis Financial Stress Index recently hit an all-time low. We have never been in a recession in America when this is below zero. If we see stress, this index should rise noticeably in the upcoming weeks working from a low bar.

St. Louis Fed Financial Stress Index eases for a second straight week to a new series low of -1.604 (normal stress=0) ow.ly/oLxO50yrUcI

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Logan Mohtashami is a financial writer and blogger covering the U.S. economy with a specialization in the housing market. Logan Mohtashami is a senior loan officer at AMC Lending Group, which has been providing mortgage services for California residents since 1987. Logan also tracks all economic data daily on his Facebook page https://www.facebook.com/Logan.Mohtashami and is a contributor for HousingWire.