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It's time to test the early warning system for the economy and stocks

  • Some early warning signs are emerging that should encourage policy-makers, business leaders, investors and even workers to make preparations for a rainy day.
  • Unemployment cannot go much lower without finally generating some wage inflation and pushing the Federal Reserve to raise interest rates more aggressively.
  • The number of new 52-week stock highs versus the number of 52-week lows have been flashing some yellow warning signs with respect to an aging bull market.
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"This is a test. This is only a test. If this had been an actual emergency, you would have been instructed to tune to one of the broadcast stations in your area."

When I was kid, the Emergency Broadcasting System would issue these test warnings on radio and TV to make certain that in the event of a serious national crisis, people would know where to tune for important information.

In that spirit, it just might be time to test the early warning system for the economy and the stock market.

There are an increasing number of signs and signals that the economy is entering the very late stages of economic recovery.

That does not mean a recession is imminent, but some early warning signs are emerging that should encourage policy-makers, business leaders, investors and even workers to make preparations for a rainy day.

Liz Ann Sonders, the chief investment strategist at Charles Schwab, noted recently that for the first time in U.S. economic history, the number of open jobs in the U.S., currently a record 6.3 million, equals the number of unemployed individuals in the nation.

Put quite simply, if each unemployed individual were matched with an open job, the unemployment rate in the U.S. would fall to zero.

While economists debate whether "full employment" is between 3 percent or 4 percent, zero would put an answer to that question once and for all.

It also suggests that unemployment cannot go much lower without finally generating some wage inflation and pushing the Federal Reserve to raise interest rates more aggressively, often a prelude to an economic slowdown, or recession.

Fed Chairman Jerome Powell's news conference later on Wednesday may well focus on the growing strength in key sectors of the economy that could lead to a greater number of rate hikes than financial markets currently expect.

To underscore that point, I spoke to a business group this week that operates in a highly economically sensitive industry. Factory operating rates in the paper and packaging industry are running above 90 percent and, in some cases, close to 100 percent.

Rapidly rising demand for boxes and corrugated paper is a key leading economic indicator. Peak demand for packaging is something that should be watched quite closely.

Given the ever-increasing demand for consumer merchandise, both in some bricks-and-mortar retail, and, more broadly, in the burgeoning on-line universe, such strength has historically coincided with a peak in economic activity.

Commodity prices, copper in particular, appear to have peaked, as well, and seemingly have begun to roll over.

The yield curve, the relationship between short and long-term interest rates, has resumed flattening out, after a brief steepening earlier in the year.

Taken together, falling copper prices and a flattening yield curve are also indicators of a potential future slowdown in economic growth.

There also have been some important divergences in the stock market of late. Broad, technical measures of stock market strength, like the advance/decline line (which shows how many stocks are rising versus falling) and the number of new 52-week highs versus the number of 52-week lows have been flashing some yellow warning signs with respect to an aging bull market that remains priced for perfection.

Another sign of late stage behavior is that merger and acquisition activity has crossed the $1 trillion mark this year at the fastest pace ever, something long associated with market and economic tops.

None of this means that a bear market is on the immediate horizon, or that a recession will come like a bolt out of the blue.

In truth, neither event occurs without adequate advance warning.

Some of those warning signs, however, are suggesting that the system may be tested again.

It may not happen this week, but if these conditions persist, history suggests a downturn is likely within the next six to nine months.

That should give everyone some time to shepherd cash, to trim overexposure to equities, if that's an issue, or to raise some cash to offset an interruption in the economic recovery or the bull market in stocks.

Remember this is only a test. But those who heed warning signs can build the necessary reserves to survive, and possibly even thrive, when the next downturn inevitably comes.