The last time unemployment was this low, we were hit with a recession

The near-50-year low in the unemployment rate signifies that a lot of good things have happened for the economy, but also could point to some bad things that could happen.

In fact, the last time the headline jobless level was lower, an economic downturn followed. December 1969 saw the rate fall to 3.5 percent, and it was at 6.1 percent a year later when the economy struggled through problems in 1970 that sound a lot like conditions now. The current unemployment rate is 3.7 percent.

Back then, the economy was coming off what at that point had been its longest expansion ever, a nearly nine-year period of prosperity that came amid aggressive fiscal expansion to finance the Vietnam War.

Growth finally started to peak, though, as 1969 came around, and by early the following year, the expansion was over.

That’s the bad news.

The good news is that what followed was a nine-month slump that is one of the mildest recessions in U.S. history. GDP was negative only twice during the year — a 0.6 percent decline in the first quarter, then a 4.2 percent drop in the fourth quarter. In between there were increases of 0.6 percent and 3.7 percent. And by the time November 1970 rolled around, the economy was back on its feet en route to a three-year expansion that saw GDP growth average 5.1 percent a year.

In fact, some economists don’t even count the 1970 downturn as a recession, instead considering it a pause in growth that quickly abated.

Investing experts are conflicted over whether the current economy is just getting revved up, on its way to another 1970-style slowdown, or ready to tumble into a late-1970’s-style inflationary spiral that will precede a much sharper downturn. GDP grew 2.2 percent in the first quarter this year and 4.2 percent in the second, and may have registered above-4 percent growth in the third quarter.

“It doesn’t give you a warm and fuzzy feeling when you see these types of unemployment rates,” said Jim Paulsen, chief investment strategist at The Leuthold Group. “I don’t really see very high odds of anything like the ’70s. That said, I think we’ve got all the makings of a normal cyclical buildup in costs and inflation.”

Put another way, while there are some similarities between the 2018 landscape and what happened in the 1970s, there are conditions in place now — demographics, technology, monetary policy — that argue against a return to a condition so drastic that former Fed Chairman Paul Volcker had to take the country into recession to cure it.

Fundamentals also are much better now than they were then. Business and consumer confidence is soaring, corporate profits are near record highs and interest rates, while rising, are still low.

But the sudden deterioration of any of those conditions, much like the slowdown happening in other parts of the world, is what worries Paulsen.

“You could get yourself into a situation where you’re growing more slowly,” he said. “A milder version, but nonetheless a version, of is a possibility.”

Paulsen worries that an overheating in the economy eventually could lead to trouble, paving the way for another tightening in financial conditions that brings the expansion to a halt. Inflation measures have been creeping higher, resulting in a push to a seven-year high in the 10-year yield.

One area of worry is the Federal Reserve.

The central bank is on a rate-hiking cycle that began in December 2015 and likely will continue through next year and perhaps into 2020. Market participants worry that the Fed will keep hiking until it inverts the yield curve, a condition where short-dated yields exceed their longer-duration counterparts. That has been a reliable recession indicator for 50 years, and it’s close to happening again.

The idea that “this time is different,” pushed by Fed officials and elsewhere, could lead investors to be complacent, said Mark Holman, CEO of TwentyFour Asset Management.

“In the absence of a major surprise, some kind of big macro problem somewhere, I think it’s going to be a mild recession and won’t last very long,” he said. “I would caveat that by saying it depends on what tips us in.”

For clues as to when and how the next recession will take hold, Holman recommends watching the Fed’s survey of loan officers, which describes current lending conditions and serves as a benchmark for how loose or tight fiscal conditions are at a given point in time.

“The day the curve does invert, your senior officers at all the big banks in the U.S. are going to be discussing their credit lending strategy,” he said. “Tightening isn’t just what the central bank does.

Ultimately, he sees recession hitting around 2020. Investors should start thinking about that day coming, though he said it’s probably premature to begin adjusting portfolios.