17 DECEMBER 2018
ANOTHER WARNING THAT A 2019 RECESSION IS COMING
by Raul Elizalde
This article also appeared on forbes.com
Judging by activity measures like retail sales, industrial production and employment, the U.S. economy does not seem to be on the brink of slowing down. But it is a perverse fact that such measures have been at their highest points, and even at record levels, just before falling a few months later under the weight of an economic downturn. Studies show that forecasters are generally blindsided by recessions, precisely because they tend to be preceded by economic strength. There is little reason to believe that it is different this time.
To the list of indicators that tend to peak before an economic turn, the seldom-discussed ratio between household wealth and income seems to follow this pattern as well – peaking before a turn. The Federal Reserve publishes it quarterly, and the last release shows it to be at a record level, just as it was before the last two recessions.
The ratio also seems to correlate with the slope of the yield curve, which
continues to flatten and is close to flashing its own recession warning.
The Wealth to Income ratio and what it means
Household wealth has doubled in the last nine years, fueled by the
quadrupling of stock prices and the full recovery of home values since the
depths of the financial crisis. On the other hand, median household income
barely rose in those nine years at a dismal 7% rate – an annual increase of less
than 1% after inflation. The main driver of financial well-being of U.S.
households today is wealth, not income.
The problem with this is that wealth depends on the ups and downs of asset
prices, and therefore a bear market can deliver a hard blow to household wealth.
Since income is not strong enough to soften the impact, a market decline may
well lead to households feeling poorer, which in turn will likely lead to
spending less. This can deepen a cyclical slowdown and increase the chances of a
The wealth to income ratio for the current quarter is sure to decline due to
weaker stock and property prices. Since income has risen only modestly, the
ratio will continue to drop unless assets resume their decade-long rally. This
decline has preceded prior recessions.
It is impossible to predict whether assets will be higher or lower in the
next few months, but the list of issues conspiring against higher asset prices –
trade wars, political instability, higher interest rates, etc. – is not
encouraging, so household wealth is likely to drop.
That is why investors and their financial advisors should concentrate on understanding the kind of risk they have in their portfolios, rather than trying to forecast the direction of the market, which is an impossible task. They must focus on navigating the next few quarters with an eye firmly trained on risk, rather than returns.