Enterprising Investor Podcast Summary: "Cam Harvey: Forecasting Recessions"
Host: Mike Wahlberg
Guest: Dr. Cam Harvey
Release Date: August 15, 2024
Introduction
In the August 15, 2024 episode of Enterprising Investor, host Mike Wahlberg interviews Dr. Cam Harvey, a distinguished economist renowned for identifying the predictive relationship between an inverted yield curve and impending recessions. Dr. Harvey serves as a Professor of Finance at Duke University and Director of Research at Research Affiliates. He is also the author of Defi and the Future of Finance. Throughout his career, Dr. Harvey has garnered multiple accolades, including nine Graham and Dodd Awards from the CFA Institute.
The Inverted Yield Curve Recession Indicator
Understanding the Indicator
Dr. Harvey begins by explaining his renowned recession indicator, which hinges on the slope of the term structure—the difference between long-term and short-term interest rates. Typically, long-term rates exceed short-term rates, forming a "normal" yield curve. However, an inversion occurs when short-term rates surpass long-term rates, signaling potential economic downturns.
Notable Quote:
Dr. Cam Harvey [01:54]: "The indicator is really a simple indicator. It just looks at the slope of the term structure..."
Origin and Development
Dr. Harvey shares the genesis of his indicator during a master's internship at Falcon Bridge Copper. Tasked with forecasting US real GDP growth, he realized the limitations of existing economic forecasting firms. Inspired by Eugene Fama's work on asset prices reflecting economic growth expectations, Dr. Harvey pivoted to using bond yields instead of stock prices, leading to the creation of his yield curve-based recession predictor.
Notable Quote:
Dr. Cam Harvey [03:14]: "I had to do something different. It had to be innovative, had to be simple."
Performance and Reliability
Since its inception in the 1960s, Dr. Harvey's yield curve indicator has accurately predicted eight out of eight recessions without any false signals. This impeccable track record underscores the indicator's reliability and significance in economic forecasting.
Notable Quote:
Dr. Cam Harvey [10:48]: "This indicator is 8 out of 8 without a false signal."
Lead Time Considerations
While the indicator is highly reliable, the lead time between an inversion and the onset of a recession varies, ranging from six to twenty-three months. Currently, with the yield curve inverted for nearly 20 months, Dr. Harvey suggests that a recession may be on the horizon.
Notable Quote:
Dr. Cam Harvey [10:48]: "The range of lead time is six months to 23 months."
Current Economic Environment
Market Volatility and Fed Policy
Dr. Harvey critiques the Federal Reserve's handling of inflation, particularly its delayed response to rising shelter costs. He argues that the Fed's prolonged high-interest rates have introduced significant economic distortions, affecting consumer behavior and corporate investment.
Notable Quote:
Dr. Cam Harvey [15:15]: "I was critical of the hikes going to five and a quarter percent in 2023."
Inflation Data Discrepancies
Highlighting the disconnect between real-time rental data and CPI figures, Dr. Harvey contends that the Fed's inflation measures are lagging and do not accurately capture current economic realities. He advocates for the use of real-time data to inform monetary policy decisions.
Notable Quote:
Dr. Cam Harvey [19:04]: "The latest CPI print... disconnect from reality."
Retail Sales and Consumer Spending
Dr. Harvey points out that nominal retail sales have flattened over the past six months, indicating that consumer spending may decline as savings are exhausted. This trend suggests muted GDP growth in the upcoming quarters.
Notable Quote:
Dr. Cam Harvey [25:19]: "Consumer spending over the next year is going to be muted."
Comparing Current Situation to 2007
Parallels with the 2007 Financial Crisis
Dr. Harvey draws striking similarities between the current economic conditions and those preceding the 2007 financial crisis. Both periods feature sustained high-interest rates and an inverted yield curve lasting 19 months.
Notable Quote:
Dr. Cam Harvey [25:44]: "In 2007, the Fed kept the fed funds rate at 5.25%... same as today."
Key Differences
Despite the similarities, several fundamental differences mitigate the risk of a hard landing today:
- Bank Leverage: Modern banks are less levered due to stringent regulatory reforms, reducing systemic risk.
- Housing Sector Stability: Unlike 2007, current housing equity levels are healthier, minimizing vulnerability to mortgage-related downturns.
- Employment Market: A robust job market with balanced job openings and unemployment rates provides a cushion against economic shocks.
Notable Quote:
Dr. Cam Harvey [25:44]: "Banks are far less after the regulatory reforms."
Soft Landing vs. Hard Landing
Dr. Harvey remains optimistic, predicting a "soft landing" characterized by a mild recession or slower economic growth, as opposed to the severe downturn experienced in 2007.
Notable Quote:
Dr. Cam Harvey [25:44]: "I think that the odds are for a soft landing."
Fed's Future Actions and Potential Outcomes
Advocating for Rate Cuts
Dr. Harvey urges the Federal Reserve to initiate rate cuts to alleviate economic pressures. He anticipates a possible 50 basis point reduction in the upcoming meeting, which would address the current yield curve inversion.
Notable Quote:
Dr. Cam Harvey [35:40]: "We will likely have a 50 basis point cut the next meeting."
Implications of Yield Curve Uninversion
Addressing concerns that an uninversion might invalidate his indicator, Dr. Harvey clarifies that historical data shows yield curves typically uninvert before a recession commences, reinforcing the indicator's predictive power.
Notable Quote:
Dr. Cam Harvey [35:40]: "This is just part of how it plays out."
Final Advice from Dr. Harvey
In his concluding remarks, Dr. Harvey offers career advice to young professionals in finance:
- Embrace Job Security Uncertainty: Expect and professionally handle potential terminations.
- Build and Maintain Networks: Even in setbacks, maintain relationships for future opportunities.
- Focus on Continuous Learning: View transitions between firms as opportunities to expand knowledge and skills.
Notable Quote:
Dr. Cam Harvey [37:14]: "You need to expect that... build a rapport, and that will come back and benefit you."
Conclusion
The episode provides a comprehensive analysis of economic indicators and Federal Reserve policies through the expert lens of Dr. Cam Harvey. His insights on the inverted yield curve, inflation measurement discrepancies, and comparisons to past economic crises offer valuable perspectives for investment professionals navigating the complexities of the current economic landscape.