Context: Over the past three decades, each recession has reliably been preceded by a positive output gap as a percentage of GDP. The measure is constructed using the difference between current GDP figures and the CBO’s estimate of potential GDP (at full utilization) and normalized as a percent of total GDP. A positive output gap signals an economy that may be running above its nameplate capacity, possibly triggering elevated inflation, excessive borrowing and risk of overheating. Since breaking into positive territory in 3Q17, the measure points towards a late stage business cycle, having averaged nine quarters of positive readings before each of the prior three recessions that occurred in 1990, 2001 and 2007. However, on a shorter horizon the reading also suggests robust near term equity market performance having averaged a 37% rise in the S&P from positive crossover to peak over the past thirty years. The best takeaway may simply be that we have emerged into a structurally different environment than prior years that will require a new manner of perception.
yep yep. interesting stuff.
chart link?
What do you mean?
I made it in BB, the series is CBOPGAPN Index . If you open it in a new tab you get a larger view of it.
https://www.seeitmarket.com/stars-remain-aligned-for-global-bull-market-into-2018-17659/
here nice article adn chart. cahrt 3
How do we see the cycle playing out?
Our base case scenario remains relatively traditional. The global economic growth continues to improve gradually, and this finally begins to translate into inflationary pressure and/or upward pressure on bond yields. Given so much asset price inflation occurred over the past decade thanks to low yields, this asset price inflation partially reverses and causes a recession. The timing of this scenario is not imminent but there are signs it may be coming. The German and Japanese economies have both been producing above their potential, which causes inflationary pressures. The U.S. has just passed over this threshold as well (Chart 3 below). Historically, this precedes recessions by a year or two.
Adding to this base case, the Fed, as mentioned above, is now expected to raise rates three times in 2018 which would put the upper band of the Fed Funds rate at 2.25%. How and when this begins to impact longer term yields will be critical and could begin multiple compression, not just in the equity markets but also in real estate cap rates.
For now, we are in the sweet spot: a healthy economy and low inflation. We will be watching inflation for a potential early warning signal that things may change. If the current relatively low inflation expectations begin to creep higher, this would likely trigger a surprise reaction in the bond market causing higher than expected yields. Some surprises are welcome, but this development would certainly be an unwelcome one. But for now, enjoy the good times.
Nice share BS
cant speak for the greater market but commercial real estate market is looking extremely late cycle. valuations & creditworthiness of borrowers has gotten pretty crazy for how tight spreads are getting. im personally interested to see what happens to a lot of borrowers from the 07 crash that are still treading water (Kushner Cos 666 Fifth ave comes to mind as a great example) if markets go wild and those borrowers arent able to secure new financing we could see a wave of foreclosures that would certainly expand cap rates.
I would love that so I can go in for the kill!!!
i don’t have BB. what is the lag time? 4 months? can this be used as a predictive measure or is it more confirmatory?
Not 100% sure on the lag but I think its primarily updated using the numerator (GDP) with potential GDP steady. Its confirmatory of the cycle and signals rising inflation which can be predictive. Given that there’s usually something like an average 6Q lag between this metric breaking above 0% and market collapses its also somewhat predictive. The issue there is that while it essentially confirms that the economy is running hot and on a limited timeline, its not a timing indicator (I don’t think those really exist) and a correction could be anywhere from a quarter to four years or more away with strong market performance in between. There’s some good info on this in the blurb above. I use it more to confirm, ok, we’ve crossed into the official late stage of the cycle and can now expect inflation. For the past three years people have been asking where the inflation was and the reality was that we only passed into a positive output gap in 3Q17.
Nice chart @BlackSwan, which indicates a late cycle situation for the economy. But maybe productivity measures are no longer valid today as they were before bc of a regime shift in production (digitilization etc). Nonetheless, the combination of output gap, indebtedness and still ongoing complacency makes me believe that we haven´t seen the worst in capital markets yet.
That’s completely silly. The non-financial corporate sector is near the highest level of leverage and total debt outstanding it’s ever been historically and I’ve demonstrated in the past that the consumer remains levered at a significant level. Taken on an absolute level, household debt is above 2007 levels in the US and there’s also China’s debt bubble which is a major source of demand globally. Lastly, liquidity is a major threat in and of itself as QE reverses and impacts asset valuations. It’s odd to me that someone could be referencing QE while completely ignoring that. This author basically conflates bank leverage / financial crises with the business cycle which is just not accurate. Business cycles have existed outside of financial sector leverage for centuries. On a related note, Dalio had a nice linkedin article out there about the current business cycle, and his rising net short positions that’s also referenced in BB today. I’m not claiming we’re on pace for imminent collapse but when the output gap turned positive the clock officially began ticking on late cycle. Given the other fundamental factors like stimulus, rising incomes and geosynchronous growth, I’m content to say we have a nice runway but the death of the business cycle at current levels of financial leverage is unreasonable.
What you’re referencing is still occurring at the margin, the refrain of “this time is different” is not a new one.
Interesting thread Props
Good post!
for those without BB, you can go to FRED and play around with their charts. you can put potential and actual on the same chart, export and create what you will.
Mmmk, I’m fine with this.
Given the positive output gap, what do you think will be the mid/long run affects of Trump’s increase in government spending and the recent cut in taxes?