1. Is There an Economic Downturn in the Near-Term Future – a Capital Markets’ Perspective?
John Lonski, MD-Chief Capital Mkt Economist, Capital Markets Research Group
September 2018

2. Emerging Markets Have Difficulty Coping with a Stronger Dollar1
Emerging Markets Have Difficulty Coping with a Stronger Dollar

3. Market Value of US Common Stock Soars as Chinese Equities Struggle … Shanghai Composite Peaked in June source: Moody's Analytics

4. Cheaper Industrial Commodities and Stronger Dollar Are Anathema for Heavily Indebted Emerging Market Countries source: Federal Reserve, Moody’s Analytics

5. Industrial Metals Price Index's Latest Dive Weighs Against an Impending and Extended Stay by 10-Year Treasury Yield Above 3% source: Moody's Analytics

6. 2
US Economy May Still Have Room to Grow without Triggering a Disruptive Climb by Price Inflation

7. Never Before Has a 3.9% Jobless Rate Been Joined By Such a High Percentage of Manufacturing Capacity Not In Use source: BLS, Federal Reserve, Moody's Analytics
... Latest Capacity-Not-In-Use Has Been Associated with a 5.3% Average for Jobless Rate

8. Never Before Has a 3.9% Jobless Rate Been Joined By Such a Slow Rate of Wage & Salary Income Growth source: BLS, BEA, Moody's Analytics
When the UR last dipped to 3.9% in Q2-2000, W&S income grew by 7.6% annually during year-ended June 2000, which was much faster than its 4.8% increase of the year-ended June 2018.

9. Current High Percentage of 25 to 54 Year Age Cohort Not In Labor Force Typically Favors a 6.4% Midpoint for Jobless Rate vs Actual 3.9% moving 3-month averages; source: BLS, Moody's Analytics
When the UR last dipped to 3.9% in Q2-2000, W&S income grew by 7.6% annually during year-ended June 2000, which was much faster than its 4.8% increase of the year-ended June 2018.

10. Recession May Be Near When Unemployment Rate's Moving Three-Month Average Turns Higher Amid a Mature Economic Recovery source: BLS, BEA, Moody’s Analytics
The unemployment rate’s moving three-month average has been less than 4% in only 5% of all the months since the end of 1967.
The jobless rate’s moving three month average bottomed at the 3.4% of October 1968 through June 1969.
A very low unemployment rate should breed caution regarding the longevity of the current business cycle upturn.

11. Within 3 Years After the Last 3 Recessions, Fed Funds Sank by -485 bp and 10-Year Treasury Yield Fell by -245 bp, On Average actual & predicted values; source: Federal Reserve, Blue Chip Economic Indicators, Moody’s Analytics

12. 3
US Treasury Bond Yields Fail to Lift-Off Despite Fast Rising Ratio of US Government Debt to GDP

13. Mandatory Spending Requirements (Social Security & Medicare) Stemming from Aging "Baby Boomers" Is Expected to Drive US Treasury Debt Up to 90% of GDP by source: CBO, Bloomberg, Moody’s Analytics

14. Historically Slow Growth of US' Total Private and Public Nonfinancial Sector Debt Reins In 10-year Treasury Yield yearlong averages; source: Federal Reserve, Moody’s Analytics

15. Elevated Ratio of Private & Public Nonfinancial-Sector Debt to GDP Reins In Treasury Bond Yields yearlong averages; source: Federal Reserve, BEA, Moody's Analytics

16. Blue Chip Survey Assigns a Range of 2. 9% to 3
Blue Chip Survey Assigns a Range of 2.9% to 3.25% for Average 10-Year Treasury Yield of 2018's Second Half

17. Ten-year Government Bond Yields Recent Yields of 0. 38% for Germany, 0
Ten-year Government Bond Yields Recent Yields of 0.38% for Germany, 0.10% for Japan and 1.31% for the UK Rein In US Treasury Yield in %; source: Bloomberg, Moody's Analytics

18. 4
Interest-Rate-Sensitive Home Sales Sag Under the Weight of Higher Treasury Bond Yields

19. Fewer Unit Home Sales Rein In Treasury Bond Yields source: National Association of Realtors, US Census Bureau, Moody's Analytics
THS average pace of three months ended July 2018 trails cycle peak of Q by -3.7%.
Index of PHS for 3-months-ended Jul-18 was down by -2.4% yy and contracted by -2.8% annualized from contiguous 3-months-ended April 2018.
30-year mortgage yield averaged 4.56% during 3-months-ended July 2018 – up 60 bp yy & up 15 bp from average of 3-months-ended April 2018.

20. 5
Default Rate’s Declining Trend Defies Record Ratio of Corporate Debt to GDP

21. High-Yield Default Rate Is Expected to Drop from July 2018’s 3.4% to 2.4% by 2019’s First Quarter source: Moody's Investors Service, Moody’s Analytics
Back in April 2018, Moody’s Default Research Group predicted that the US’ high-yield default rate would fall from the 3.65% of 2018’s first quarter to 1.9% by 2019’s first quarter. Since then, the Default Research Group has a less benign view of defaults and now expects the default rate to slide from the 3.7% of 2018’s second quarter (including June’s 3.4%) to 2.5% by 2019’s first quarter. Trade-related uncertainties, the softening of important foreign economies, and the FOMC’s upwardly revised outlook for fed funds despite slippage abroad, lower industrial metals prices, and lower home sales in US are consistent with the upward revision of early 2019’s expected default rate. The recent sideways movement by the high-yield bond spread favors a 3.0% midpoint for October 2018’s default rate, which practically matches the 3.1% predicted by the Default research Group. A default rate forecasting model employing the high-yield bond spread of three months back generates a very strong adjusted R-square statistic of the high-yield spread’s default forecasting ability deteriorates noticeably moving beyond three months.

22. Default Rate Last Sank Amid a Fast Rising Ratio of Corporate Debt to GDP during the Late 1980s source: Moody's Investors Service, BEA, Moody's Analytics

23. Ratio of Corporate Debt to Profits Looks Far Less Alarming than the Ratio of Debt to GDP source: Moody's Investors Service, BEA, Moody's Analytics
892.6% 927.4% 730.8%
Recent 731% ratio of corporate debt to profits from current production is less than its 893% median when the ratio of corporate debt to GDP was between 44% and 45%.

24. Rising Trend for Profits Offsets the Loss of Credit Quality to a Steep Ratio of Corporate Debt to GDP in Late-1980s and Today US nonfinancial corporations; source: BEA, Moody's Analytics

25. Each Deeper Than -5% Drop by Profits from then Record High Was Joined by a High-Yield Default Rate in Excess of 5% source: Moody's Investors Service, BEA, Moody’s Analytics
Back in April 2018, Moody’s Default Research Group predicted that the US’ high-yield default rate would fall from the 3.65% of 2018’s first quarter to 1.9% by 2019’s first quarter. Since then, the Default Research Group has a less benign view of defaults and now expects the default rate to slide from the 3.7% of 2018’s second quarter (including June’s 3.4%) to 2.5% by 2019’s first quarter. Trade-related uncertainties, the softening of important foreign economies, and the FOMC’s upwardly revised outlook for fed funds despite slippage abroad, lower industrial metals prices, and lower home sales in US are consistent with the upward revision of early 2019’s expected default rate. The recent sideways movement by the high-yield bond spread favors a 3.0% midpoint for October 2018’s default rate, which practically matches the 3.1% predicted by the Default research Group. A default rate forecasting model employing the high-yield bond spread of three months back generates a very strong adjusted R-square statistic of the high-yield spread’s default forecasting ability deteriorates noticeably moving beyond three months.

26. Benign Default Outlook Assumes Coverage of Net Interest Expense Does Not Worsen US nonfinancial companies; source: BEA, Moody’s Investors Service, Moody's Analytics

27. 6
Richly-Priced US Equities Find Support from Profits Growth, Tolerable Interest Rates, and Declining Default Rate

28. Highest Aggregate Price:Earnings Ratio since Q Gets Support from Very Low Corporate Bond Yields source: BEA, Moody's Analytics

29. Since 1992, 90% of the 174 Year-to-Year Declines by the Monthly Default Rate Were Joined by a Year-to-Year Increase for the Market Value of Common Stock

30. Recent VIX Favors a 380 basis points High-Yield Spread … Medians Are 16.0 Points for VIX and 460 bp for High-Yield Spread source: CBOE, Moody's Analytics

31. 7
Electric and Gas Utilities Help to Contain Consumer Price Inflation amid a Very Low unemployment Rate

32. Annual Rates of Consumer Price Growth for 3-Months-Ended Jul-18 Are 2
Annual Rates of Consumer Price Growth for 3-Months-Ended Jul-18 Are 2.3% for Core CPI, 0.0% for Electricity and -1.4% for Natural Gas source: BLS, Moody's Analytics E

33. Capacity Utilization Rate Trends Lower After Averaging 93
Capacity Utilization Rate Trends Lower After Averaging 93.2% during … Was at 78.0% in July 2018 source: Federal Reserve, Moody's Analytics
% 3.7% % 2.3%
Despite hot summer and a sizzling economy, seasonally-adjusted electric & gas utility production fell in each of the three-months-ended July. July’s electric & gas utility output rose by a modest 2.3% from a year earlier.
July’s electric power generation, transmission & distribution dipped by -0.9% from June and edged up by 1.4% from July 2017.
July’s total IP was up by 4.2% yy, wherein manufacturing output increased by 2.8% and natural resource output advanced by 12.9.

34. © 2014 Moody’s Analytics, Inc
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