Now is not the time to give up on equities

An inverted yield curve has historically been a telltale sign of recession. But before selling your equities, senior portfolio manager Craig Jerusalim advises taking a look at other economic indicators.

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“A yield curve inversion does not cause recessions,” said Jerusalim, who manages Canadian equities at CIBC Asset Management, in a late August interview. “It has just preceeded recessions due to the circumstances at the time of lower perceived growth, and the flight to the safety of Treasurys. The timing mechanism from inversion to recession has ranged from 12 to 24 months on average, so [it’s] not the greatest timing tool.”

Other factors might be sending mixed signals and distorting interest rates, he said, pointing to quantitative easing and the “$17 trillion of negative-yielding government debt that’s dragging down rates.”

“That is why we need to examine some of the other economic indicators we have at our disposal before writing off the cycle and potentially missing out on some decent upside,” said Jerusalim, who co-manages the Renaissance Canadian Small-Cap Fund.

Here are six such indicators.

• Unemployment

Jerusalim points to the U6 unemployment rate, which incorporates people who are unemployed, no longer looking for work, or unable to work. The U6 rate in the U.S. has dropped from 8.1% in January to 7.2% in August.

“Although it is as low as it has been in decades, it is still falling, as workers who had left the workforce are re-entering due to increased levels of optimism,” said Jerusalim. “So, nothing to worry about here.”

• Housing

An overbuild in housing can cause prices to fall, which often proceeds a recession, Jerusalim said.

“The good news is that housing starts, post the financial crisis, haven’t made their way back to the long-term average, despite the larger population today,” he said. “Plus, housing permits, a better leading indicator, continue to show positive trends.”

U.S. housing starts have declined in recent months and are down for the year, while building permits increased 8.4% in July from June.

• Purchasing managers index (PMI)

PMIs have recently fallen in the U.S. and globally. A PMI level below 50 indicates contraction, while a number above 50 indicates expansion, Jerusalim said.

The Institute for Supply Management’s index slid to 49.1 in August, from 51.2 in July. The August figure was the lowest since January 2016.

“However, when combined with the more relevant servicing component of the economy, we are still in expansionary territory, despite recent dips,” said Jerusalim. “This is something we will definitely need to keep an eye on moving forward.”

• Credit trends

Financial markets are still showing “accommodative conditions,” and investment-grade corporate spreads are “showing quite benign credit trends,” he said.

“Spreads have widened from historic lows, but are still well below long-term averages and nowhere near levels that would raise red flags,” he added.

• Small-business confidence

Small businesses, the “engines” of the U.S. economy, continue to express “robust” levels of optimism, Jerusalim said. “This bodes well for hiring, investments and future growth.”

The National Federation of Independent Business (NFIB) Small Business Optimism Index dropped 1.6 points in August from the month before. However, the 103.1 score showed sentiment was still higher than normal.

• Consumer confidence

Consumer confidence, savings rates and consumption trends “are still fairly positive,” Jerusalim said.

The University of Michigan’s U.S. consumer sentiment index saw its biggest drop in seven years in August, which may reflect worries about the impact of tariffs. Retail sales rose slightly in August, though at a slower rate than the previous month.

“Even if your gut instinct is telling you to sell equities, the evidence is still pointing to economic expansion,” Jerusalim said—regardless of the headlines in the business news.

“Over the long term, market timing has proven a very poor strategy. Instead, stay invested in high-quality, growing companies with prudent balance sheets and defensible competitive conditions in order to reap the benefits of long-term capital compounding.”

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