Recession redux? Reading between the lines of the latest economic data

A perspective from E*TRADE Capital Management, LLC


Last week, two important economic reports were released—one focused on unemployment and the other on industrial production.

On the surface, these are not the most stimulating of reads. Even for those who take an interest in economic data, the two reports likely netted a passing glance at best: Unemployment? Down. Industrial production? Up. Over and out.  

But beyond the headline numbers are some interesting insights that may have implications for investors.

US unemployment dipped below 4% in July

Let’s start with the July unemployment figures, courtesy of the Department of Labor, which came in at 3.9% for July. This continues a steady downward trend that began in 2009.

Unemployment rates below 4% are rarefied territory. Sure, we’ve been there before, but not in quite a while. Aside from April’s 3.9% figure, you would have to go back to the fall of 2000 to find a smaller percentage of the US labor force out of work. In the era of dial-up modems, AOL, and AltaVista, unemployment dipped to 3.9% for four consecutive months before the tech bubble finally burst.

And the best numbers before that? Mike and Carol were introducing their boisterous brood of Bradys to the world when unemployment bottomed out at 2.8% in 1969. That was a tumultuous time in America, and many of the country’s young men were fighting in Vietnam, keeping labor participation rates below 60%.

What comes next? The historical record

We looked back at the past 50 years to see what happened after past troughs in unemployment. The results aren’t pretty. Naturally, unemployment rates rose—these were troughs, after all. But they didn’t exactly inch upward. In fact, within a year of nearly all unemployment lows, the US economy lurched into recession and unemployment skyrocketed.

US unemployment rate

Source: Bureau of Labor Statistics, U.S. Department of Labor

Are we implying this will happen again? Not at all. But given the flattening Treasury yield curve, the length of the current economic expansion, and the potentially adverse effects of tariffs and trade wars, the historical record may prove a cautionary tale.

Industrial production is on the rise. That’s good, right?

Every month the Institute for Supply Management releases its ISM® Manufacturing Index—a broad barometer of industrial production. On the surface, the latest numbers look good. In July, industrial production expanded, with 17 of 18 industries in the manufacturing sector showing growth. 

Look closer, though, and you’ll see that industrial production has been range-bound for about a year, putting the brakes on an upward trend that began in the second quarter of 2015.

US industrial production

Source: Institute for Supply Management

Coinciding with decelerating industrial output are rising business inventories and lower customer backlogs. Rising inventories, which add to gross domestic product, could signal that businesses are anticipating higher future sales. Alternatively, they could telegraph that slower-than-anticipated sales are creating an inventory overhang. A relatively flat inventory-to-shipments ratio since March may hint at the latter.
Source: Institute for Supply Management

Source: Institute for Supply Management

The bottom line for investors

While we’re not calling an end to the economic joy ride, the go-go economy has burned through a lot of fuel and may be due for some maintenance. In the interim, investors may want to keep an eye on some broader themes:

•  Value stocks. While value stocks are often sensitive to economic cycles, they can also do well in risk-off environments, when investors tend to be more discerning in their equity selections. With interest rates on the rise, it’s worth noting that during the last period of sustained interest rate increases, from 2002 to 2006, value stocks outperformed growth stocks for 15 consecutive quarters.1 History notwithstanding, value stocks may warrant consideration based on valuations alone.

•  Energy stocks and financials. These are two of the largest weightings in value indexes at the moment, and conditions for both sectors are favorable. With interest rates on the rise, financials could benefit from rising net interest margins. (Conversely, net interest margins could shrink if the yield curve continues to flatten.) As for energy, some analysts believe US sanctions on Iran, combined with supply disruptions in Venezuela and Libya, could push oil prices above $90 per barrel by year-end.2

•  Dividend stocks. When the economy does eventually slow, dividend-paying stocks may offer defensive characteristics that can help steady returns during periods of market volatility.

Can unemployment rates go lower? Can industrial production keep rising? Possibly, on both counts. But given that many economists expect growth rates to moderate as we inch closer to the fourth quarter, this may be a good time to assess your portfolio’s defensive line. The measure of a portfolio isn’t how it does in bull markets, but how well it withstands a wide range of market conditions.

1. MarketWatch, “This may be the best time for value over growth stocks in 17 years,” April 3, 2018.

2. CNBC, “US sanctions on Iran are set to keep oil prices elevated, analysts say,” Aug. 6, 2018,