European exchange-traded fund provider Source believes the US economy still has momentum – and equities are set to outperform – despite several economic indicators “flashing red”.

Paul Jackson, Head of Research at Source.

As of the end of Q3 2016, the US economy had just completed the 29th quarter of its current economic expansion. This duration of growth equates to the average length of all previous expansions since 1950, although these past growth phases ranged between four and 69 quarters.

Source notes the US economy has been exhibiting warning signals of a possible upcoming recession as investment levels, US corporate profits, and the stockmarket have declined over the last two years. Research shows these three factors have tended to precede the last eight recessions.

Paul Jackson, Head of Research at Source, commented: “A sombre interpretation of our analysis is that the indicators are predicting a recession and, as the Fed has limited scope to loosen, it could be quite bad. In this case, treasuries and gold may be the only places to hide.”

Despite the presence of these ominous economic signs, Source believes the US economy may still have the opportunity to make another bounce-back. It notes that the current economic expansion has been gradual, with total growth of 15.5% since the bottom of the previous recession, compared to average growth during previous expansions of 31.3%.

Jackson notes: “Given it has been a gentle walk rather than a sprint, it is easy to imagine that the US economy retains some energy. The optimistic interpretation is that the recent weakening of stocks, profits and investment was associated with the weak growth of the last year, rather than with a classic recession.

“If that is the case, the fact that wage and price inflation is not excessive, that the Fed is tightening only very slowly and that the yield curve is far from negative gives some hope that this cycle will get a second wind over the coming quarters. If so, stocks will go higher.”

Source also notes that investment levels, corporate profits and stock market performance have emitted false signals in the past. For example, stocks have produced 18 such signals since 1951, profits have done so on 21 occasions, and investment 22 times since 1950. Yet there have only been eight recessions over the same period.

What appears to be more relevant to these indicators’ predictive power are the moments when they coincide. The analysis shows there have been six periods when all three measures were aligned and recessions followed on five of these occasions. The current situation is different in that the S&P 500 has not had two successive down quarters, although it has been close: the previous three quarters have yielded growth of just 0.9%, 0.8% and 1.4%.