What predicts a recession?

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by Dave

I trained up a “recession detector” using as the training key the “USREC” (US recession declared) monthly timeseries from FRED, with the longest-dated macro timeseries I could find from FRED.  These included: PPIACO, INDPRO, BAA, AAA, DJI, DJT.

In my training session, I trained the model on data from 1920-2004.  Then I presented it with data it had never seen before: 2005-2018.  Given that “new” data, it was properly able to predict the 2008 recession, but it also (curiously) saw Chris’s 2016 recession that never was.

What predicts a recession?

  • Declining DJT/DJI ratio (weight 5..10, immediate)
  • Declining INDPRO (weight 40..50, immediate)
  • Declining PPIACO (weight 30, immediate)
  • Rising AAA rates (weight 15..20, delay 12 months)
  • Rising BAA rates (weight 20..30, delay 6 months)
  • Rising BAA-AAA ratio (weight 15…40, immediate)
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INDPRO tipped over in early 2015 and dropped for a full year.   PPIACO did much the same thing.

Is this the holy grail?  It might be.  I watch it every month.  You can watch the raw indicators too: INDPRO continues to look strong, so does PPIACO.  Rates, on the other hand, have been rising; they are a ticking timebomb.  Notice how they have a “delay” attached; and the pressure starts relatively low, and slowly builds until things pop.

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Its really fun when the model matches up with how you think the world should work.  The best part are the specific weight & delay numbers that pop out.  Of course, these are just average correlations that happen across all recessions 1920-present, so…YMMV.

From what I can see, the time to panic is when you see INDPRO and PPIACO tip over, after seeing AAA and BAA rates rise for 6-12 months.  Transports leading industrials lower is icing on the cake.


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