The Recession Buy Indicator (RBI) could be an investor’s best heads-up that the bottom in risk assets is in play.
The criteria for a recession, two negative quarters in GDP could be satisfied.
Speculation that the world’s largest economy is in recession will be laid to rest when The Federal Reserve will soon release the US GDP data, scheduled for July 28, which is likely to show another contraction in GDP.
Assuming the data is neutral, the recent 75 basis point hike in July combined with costs push inflation in energy and food are likely to be strong headwinds on aggregate demand and drag the US economy into recession.
So this period is not similar to the roaring 20s post the pandemic boom, and a recession is now virtually unavoidable. The duration and severity of the recession depends on the extent the Fed continues to tighten liquidity from the system in an economic downturn. Investors should prepare for the worst if the Fed continues with monetary tightening and ignores the warning signs of an economy in distress, two consecutive declining GDP quarters, and the inverted 2s 10s yield curve.
As Darren Winters points out, another Great Depression could be on the cards if the Fed chooses to fight cost-push inflation, a battle it knows it can not win, with contractionary monetary policy.
So it is in this context we zero in on RBI as a contrarian indicator.
The crux of RBI is the darkness before the dawn scenario
In other words, RBI points to peak hawkishness, where central bank liquidity reaches a trough then starts rising. In this scenario of increasing liquidity from trough levels, capital flows rotate into beaten-down risk assets as investors scoop up bargains, companies riding the innovation wave. Blockchain technology and companies active in the fourth revolution. Investors should seek companies riding macro trends driven by policy. The mass electrification of transport and infrastructure associated with it is an example.
So, when the economy booms and central bank liquidity has peaked, risk assets prices are the first to fall. When investors and speculators see further indications of a slowing economy combined with central bank policy pivoting to fight inflation, demand for risk assets collapse. That played out in the first half of 2022, with approximately seven trillion wiped off technology growth stocks and cryptocurrencies, in a backdrop of the Fed tightening liquidity and recession indicators flashing red.
As the RBI flashes green risk-on assets, the first to fall as liquidity tightens as the economy peaks are the first to rise as the economy and liquidity reach a trough and begin rising
Risk-on assets have bounced from their lows in the last two trading weeks. Some argue this is a bear market rally, but others point to RBI as a bullish indicator.
Has the RBI been a successful indicator for investors attempting to bottom pinch, which is the name of the game, buy low, sell high?
Exhibit one, Darkness Before The Dawn, illustrates S&P returns since 1871 on an inflation dividend adjusted basis.
RBI could be the darkness before the dawn
The S&P returned since 1871 on an inflation dividend adjusted basis.
Buying when the RBI flashes green has returned alpha in both 3 months, 6 months, and 12-month periods over the last 151 years
The first three months of buying on RBI gives 2% alpha returns, after 6 months return is approximately 3% alpha, with mega alpha coming at 12 months at approximately 6% return above the S&P 500.
Bulls will argue that we are just entering the first three-month alpha period of the RBI.
The RBI bulls have a case, as it is hard to argue against 151 years of data
So the RBI is a green light for investors to buy stocks when it becomes clear that the US economy has been in a recession. That realization typically occurs around the seventh month of the downturn, given the traditional definition of a recession and the time lag for economic data to be gathered and reported.
Put another way RBI is saying buy growth risk-on assets around now, if July’s GDP data indicates a recession.
Darren Winters explains; the Recession Buy Indicator was created by Norman Fosback, who for several years beginning in the 1970s was president of the Institute for Econometric Research. In the May 8, 2008, issue of his newsletter Fosback’s Fund Forecaster, which is no longer published, Fosback reported that the Recession Buy Indicator (RBI) had an “incredibly accurate” record.
Here is the caveat with RBI
Anyone who has survived long enough in the game knows not to be overconfident about anything. The unknowns of the unknowns, the black swans are always lurking.
The most significant geopolitical event of the century is in play
US hegemony is being challenged.
Russia is reasserting itself as a great power unwilling to submit to US hegemony. So the kingpins are at war. Russia holds a powerful hand, energy, food, and a military to dominate logistical shipping ports. Russia rules over the Black Sea. Vital or strategic commodities or goods can now only enter or leave the Black Sea port with Putin’s Kremlin approval.
Vital commodities, food crops and energy have become weaponized. Going against Russia could mean the collapse of your economy and political instability from within. Clown Bojo would have survived if the UK economy was not a basket case. The civil unrest in France, Italy, and Holland is likely due to higher energy costs. The civil unrest in Sri Lanka is another example.
Russian foreign policy can drive up US core inflation, and the Fed is powerless to tackle it other than creating a great depression.
Will the West figure out a smarter way to deal with Russia? Alternatively, all the indicators including RBI become irrelevant.