Red or Blue, Rich or Poor — Recessions Don’t Care: ISM Key Indicator

Key Takeaway

• Despite biases in economic data, near-term recession risk remains low but can rise quickly, independent of these biases.
• The ISM Manufacturing Index is crucial for predicting recessions due to its role in linking soft and hard data.
• Political and wealth biases in survey data have minimal impact on robust recession prediction frameworks.

Recession Risk and Data Bias

The debate over whether political affiliation and wealth disparities are skewing recession risk assessments has gained traction. However, the core question for investors remains: does this bias significantly impact the prediction of economic downturns? According to Bloomberg's Simon White, while some bias exists in economic data, it is not substantial enough to distort robust recession predictions. Near-term recession risk remains low but could escalate quickly, independent of data bias.

Political bias is evident in some survey data, such as the Michigan Consumer Sentiment Survey, which shows a significant optimism gap between Democrats and Republicans. Similarly, the NFIB’s Small Business Optimism Index and the Conference Board’s Consumer Confidence Index may exhibit a skew based on the political party in power. Despite these biases, these surveys are considered tier-2 data for predicting recessions. More reliable indicators, such as the manufacturing ISM, play a crucial role in forecasting downturns by bridging soft and hard data.

Importance of ISM Data

The manufacturing ISM stands out as a critical indicator due to its ability to turn down before a recession begins. Its significance lies in its role as a conduit between survey data and market reactions, which ultimately influence hard data. The ISM's early release each month and minimal revisions make it a valuable tool for investors. Despite some views that its importance has waned, the ISM remains a key data point for predicting economic downturns.

Recessions typically develop through a negative feedback loop between hard and soft data. Deteriorating hard data impacts soft and market data, which in turn affects the wealth effect, leading to reduced investment and spending. This cycle feeds back into worsening hard data, potentially triggering a recession. The ISM's role in this process underscores its importance, even though it should not be viewed as a standalone predictor.

Wealth and Political Bias in Data

The notion that hard and soft data are biased by wealth inequality, with hard data favoring the better off and soft data the less well off, lacks substantial evidence. Both wealthier and less wealthy households show negligible relationships with hard and survey-based data. However, market-based data has a stronger relationship with net worth, particularly for wealthier households due to their higher exposure to financial assets.

Credit spreads, which have a closer relationship to unemployment, show a higher correlation with the net worth of less wealthy households. This suggests that while wealth disparity may influence certain data points, it does not significantly bias the overall economic data used for recession predictions. Political bias in data that matters for recession prediction is also minimal and can be smoothed out by considering state heterogeneity.