Recession Lessons: A Look Back at 1990

Recession Indicators Update

Recession Lessons: A Look Back at 1990

Our Recession Risk Dashboard continues to signal caution, with no changes from September. Meanwhile, we continue to explore how the model would have fared ahead of past pullbacks -- such as the recession of 1990.


Key Takeaways

  • There are no changes to the ClearBridge Recession Risk Dashboard this month, with the overall signal remaining yellow.
  • Tight Fed policy, the savings and loan crisis and the Gulf War all contributed to the 1990-91 recession. The ClearBridge Recession Risk Dashboard would have reflected these building pressures in its financial and inflationary segments early on while the consumer segment wouild have deteriorated last.
  • The overall dashboard signal would have turned red in June 1989, just over one year before the start of the recession.

ClearBridge Recession Risk Dashboard Still Signals Caution

The S&P 500 Index made another new all-time high in October, as trade tensions eased, the Fed cut interest rates another 25 basis points (bps), and corporate earnings came in stronger than anticipated. Against this backdrop, the ClearBridge Recession Risk Dashboard remained at an overall yellow signal, with no changes during the month (Exhibit 1). Third quarter gross domestic product (GDP) came in above consensus expectations at 1.9%, representing a slight slowdown from the pace of 2.0% in the second quarter and 3.1% in the first quarter. With both the U.S. and global economies clearly slowing, the question remains if we are on the cusp of a recession or a late-cycle slowdown.

Exhibit 1: ClearBridge Recession Risk Dashboard

ClearBridge Recession Risk Dashboard

Data as of Oct. 31, 2019. Sources: ClearBridge Investments, BLS, Federal Reserve, Census Bureau, ISM, BEA, American Chemistry Council, American Trucking Association, Conference Board, and Bloomberg. The ClearBridge Recession Risk Dashboard was created in January 2016. References to the signals it would have sent in the years prior to January 2016 are based on how the underlying data was reflected in the component indicators at the time.

A Closer Look at the Early 1990s Recession

The early 1990s recession was one of the shallower recessions in modern history with GDP contracting just -0.2% in nominal terms and the S&P 500 experiencing a selloff of 20%. For reference, this compares with -3.3% and -57%, respectively, during the global financial crisis (GFC) in 2009. Like many U.S. recessions, a myriad of factors contributed to slower economic growth.

However, the 1990 recession differs from history in that it lacks a clear single catalyst like housing in the last cycle or the tech bubble in the late 1990s. Instead, three major themes led to the recession: an aggressive round of Fed tightening, the savings and loan (S&L) crisis, and the oil shock associated with the first Gulf War. Importantly, numerous indicators on the ClearBridge Recession Risk Dashboard would have flashed caution prior to the recession.

1987–1988

Early 1987 marked the cycle low for both inflation and interest rates, with Core CPI troughing at 3.8% and moving to 4.5% by late 1988. In response, the Fed acted quickly and aggressively with the recent memory of double-digit inflation from the early 1980s. The Fed funds rate was hiked by 387 basis points, peaking at 9.75% in early 1989. This hawkish Fed policy response would have caused the Money Supply indicator to flash yellow early on and to be in red territory by the end of 1988 as Fed interest rate hikes took hold.

The Fed didn't raise interest rates in a straight line, however, and cut rates by 75 bps in the wake of the October 1987 Black Monday stock market crash. This was the only single-day bear market (a drop of -20% or worse) in history. The crash, which could not be repeated today due to the “circuit breakers” stock market exchanges implemented in subsequent years, ultimately did not spread to the real economy.

A final dynamic in this period was the beginnings of the S&L crisis. Between 1986 and 1989, 296 savings and loan associations failed. As interest rates began to rise, S&Ls were faced with higher funding costs while many of their assets were fixed rate loans (often backed by real estate). As funding costs began to move higher than the returns these institutions could earn, they began to engage in more speculative activities. In 1986 and 1987, the Federal Savings and Loan Insurance Corporation (FSLIC) — a central institution similar to the FDIC for commercial banks — was recapitalized by over $25 billion to help backstop insolvent S&Ls. However, by 1989 it was insolvent itself, with losses approaching $4 billion.

1989

In 1989, the FSLIC was wound down and Congress created the Resolution Trust Company (RTC), which helped resolve the growing crisis. While 747 S&Ls would shut down by 1995, the losses to taxpayers were partially offset by equity partnerships to liquidate the assets of insolvent institutions.

The ClearBridge Recession Risk Dashboard would have reflected this growing systemic risk, as financial indicators such as Credit Spreads and the Yield Curve would have moved from green to red in 1989. The overall signal would have turned yellow in early 1989, as the consumer section of the dashboard would have remained the last pillar of strength for the economy. However, in the second half of that year, three of the four consumer signals would have turned yellow, while business activities indicators such as ISM New Orders and Truck Shipments would have turned red, driving the overall signal to red.

Exhibit 2: Evolution of Dashboard 1988-1991

ClearBridge Recession Risk Dashboard Evolution (1988-1991)

Sources: ClearBridge Investments, BLS, Federal Reserve, Census Bureau, ISM, BEA, American Chemistry Council, American Trucking Association, Conference Board, and Bloomberg. The ClearBridge Recession Risk Dashboard was created in January 2016. References to the signals it would have sent in the years prior to January 2016 are based on how the underlying data was reflected in the component indicators at the time.

1990–1991

By the time equity markets peaked in May 1990, the dashboard was deep into red territory. While the Fed had begun to lower interest rates in mid-1989, the lagged effects of prior Fed tightening were still being digested. The recession was cemented when Iraq invaded Kuwait in early August. Oil had been trading in the $15-20 range prior to the invasion, and peaked at $40 in October before settling back to $25 by year end.

The runup in oil prices immediately hit both consumer and business confidence, which plunged in the months following the invasion. The unemployment rate began to climb in mid-1990, and the final consumer signals which had been yellow - Housing Permits and Retail Sales - would have turned red, making for an all-red dashboard. Equities sold off by 20% in a relatively truncated period of 87 days. The recession was relatively shallow and oil prices stabilized in 1991 as Operation Desert Storm led to the liberation of Kuwait. Consumer confidence rebounded and the stock market recovered its losses and more by the end of 1990.

Recession Risk Indicators Can Help Guide Investors

Our analysis finds the ClearBridge Recession Risk Dashboard would have been effective in helping clue investors into the growing economic pressures ahead of the 1990-91 recession. While the Gulf War was not something the dashboard could have predicted, the overall signal from the dashboard would have been red well before this event, suggesting the economy was weakening and particularly vulnerable to shocks such as a rapid rise in oil prices. Ultimately, the economy recovered fairly quickly and embarked upon a 10-year period of growth.


Definitions:

A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

Black Monday on October 19, 1987 was the date when a sudden, severe and largely unexpected systemic shock impaired the functioning of the global financial market system, roiling its stability through a stock market crash, along with crashes in the futures and options markets.

The Consumer Price Index (CPI) measures the average change in U.S. consumer prices over time in a fixed market basket of goods and services determined by the U.S. Bureau of Labor Statistics.

The Core Consumer Price Index (Core CPI) excludes the prices of food and energy, which are volatile on a monthly basis, from the basket of goods used to determine the CPI.

A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness

The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the U.S. federal government that preserves public confidence in the banking system by insuring deposits.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Savings and Loan Insurance Corporation (FSLIC) is a defunct U.S. government institution that provided deposit insurance to savings and loan institutions until its dissolution at the end of the 1980s.

The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s, to which it is often compared.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The Gulf War (2 August 1990 – 28 February 1991), codenamed Operation Desert Shield (2 August 1990 – 17 January 1991) for operations leading to the buildup of troops and defense of Saudi Arabia and Operation Desert Storm (17 January 1991 – 28 February 1991) in its combat phase, was a war waged by coalition forces from 35 nations led by the United States against Iraq in response to Iraq's invasion and annexation of Kuwait arising from oil pricing and production disputes.

The Institute for Supply Management's (ISM) Purchasing Managers Index (PMI) for the US manufacturing sector measures sentiment based on survey data collected from a representative panel of manufacturing and services firms. PMI levels greater than 50 indicate expansion; below 50, contraction.

The ISM New Orders Index is the new orders component of the ISM PMI.

The Resolution Trust Corporation (RTC) is a now-defunct temporary federal agency. From 1989 to 1995, it largely resolved the savings and loan (S&L) crisis of the 1980s.

The savings and loan (S&L) crisis was a slow-moving financial disaster. The crisis came to a head and resulted in the failure of nearly a third of the 3,234 savings and loan associations in the United States between 1986 and 1995.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.