US
Recession Coming Soon; Equities Bull Market Ending and Bear Growling
by Victor Sperandeo with the Curmudgeon
Introduction (Curmudgeon):
Economists in The Wall
Street Journals latest monthly survey of economists put the odds of a
recession occurring within the next four years at nearly 60%. Its important to note that the US economy
has never grown for more than a decade without a recession. The current
expansion began in June 2009, and has now continued for 88 months, making it
the fourth-longest period of growth in records stretching to 1854.
Economists polled by
the Journal forecast a 20% chance of a recession within the next year, and see
those odds rising as the time window gets longer. Asked to name the specific
risks, a plurality cited the possibility of a global economic slowdown, which
could be largely beyond the next US Presidents control.
In this post, Victor
provides his forecasts for the US economy and believes a recession is
imminent. Based on several factors, he
believes that the 7+ year US equity bull market is soon coming to an end and
the bear is waiting in the wings.
Easy money and the
expectation of a reasonably good 3rd quarter GDP number are
currently supporting the US stock market.
Weve written at length about reckless monetary policies driving up
financial assets while having a negative effect on the US and global
economy. Enough said on that topic. Lets first look at 3rd quarter US
economic growth, before Victor explains why he feels a recession could start in
the 1st quarter of 2017.
US Economic Growth to Weaken- No Recovery from Last
Recession (Curmudgeon with quote from John Williams):
The Conference Board is forecasting a
2.4% increase in real GDP (seasonally adjusted) for the Q3-2016. The Atlanta Fed GDPNow model
forecast is 1.9% as of October 14, down from 2.1% on October 7 and 3.7% this
August (almost a 50% decline in only two months). Thats shown in the chart below along with
the range of forecasts (2.3% to 3.2%) from the Blue Chip economic
indicators consensus1.
Chart
courtesy of the Atlanta Fed.
Note 1. Blue Chip Economic Indicators is an organization that
compiles consensus macro forecasts. The Blue Chip Economic Indicators is a
publication that surveys leading business economists and from the interviews
derives a 16 page monthly report. The report offers
forecast for real GDP and 15 other macro variables.
..
Our esteemed colleague
and very well respected economist John Williams at ShadowStats shares the
Curmudgeons views on the real economy.
He wrote in an email on October 15th:
I contend that we never fully recovered from the so-called
Great Recession, the economic collapse into 2009. Further, the economy already is has turned
down into a "new" recession, irrespective of the poor-quality
reporting in the GDP. You can see it in
negative annual growth in industrial production, S&P 500 real revenues,
help-wanted advertising and domestic freight traffic, among the better-quality
indicators.
..
Another candid
assessment of the sorry state of the US economy argues that The
US economy is in desperate need of a strong dose of fiscal penicillin. We definitely agree!
After the 3rd
quarter GDP number is reported to be weaker than expected at the end of
October, Victor expects downward economic momentum to accelerate in the 4th
quarter. We now pass the baton to him
for the rest of this post (other than one supporting comment from the
Curmudgeon).
Why the US Economy Will
Soon Be in Recession (Victor):
Like most observers, I
believe the Fed will raise short term rates at their December 14th
meeting. Such a rate hike is in part
psychological, but also the Fed catching up with all other interest rates
increases.
Three month Libor is up
44% this year (1 year -from 10/16/15 to date- Libor is + 177.6%). US Treasury
Bonds are down (
-7.72%) using T Bond futures prices. [The high was July 8th @176.29 (Sept
futures), and Friday 163.08 on the (Dec futures). The lows of the year were the
April 25th lows or another -2.8% from Fridays close. The current 30-year T
Bond yield is 2.55%.]
The Fed is following
the fixed income market, not leading it. The world has ended lowering rates at
this point. All bonds are rising in yield. Fiscal policy (i.e. infrastructure
spending) is now in play, yet its been missing in action for a very long
time.
Rates will continue to
rise and debt will increase. Therefore, auto and sub-prime loans, real estate,
building, and business of all kinds will slow dramatically as adjustable rate
mortgage (ARM) payments increase. Oil prices are also rising, which inhibits
consumer spending. All kinds of credit
growth (including margin debt to buy stock) will contract. Forget debt being 3%
of GDP (the EU rule). There are no rules in the world anymore.
That is why you will
get a recession. I believe it will
happen very quickly (after Christmas) as the world is a House of Cards. The catalyst to a quick economic decline is
the end of expanding credit, which has risen exponentially as per this
chart:
Reasons Why US Equity
Bull Market Is Ending and the Bear is Growling (Victor):
The expected 2017 stock
market decline could get nasty. The
S&P 500 could be down as much as 40-50% from its all-time high by June
2017. Consider the following factors:
1. Interest rates will rise in December.
US interest rates are
going to be raised at the December 14th Federal Reserve meeting, or
else the Fed will lose all credibility.
This will be the major catalyst causing the end of the Equity Bull
Market that has been in place since March 2009. It will not be the primary
cause, which is a lack of responsible fiscal policy worldwide. Specifically, tax cuts have been bypassed in
lieu of reckless experimental monetary policies in a failed effort to create
economic growth. If people don't have
money and are afraid of more debt, they can't (or wont) spend.
Rates will continue to
rise as every major central bank knows that QE is a failure, and has done great
damage to banks, pension funds, and insurance companies. THIS GAME IS
OFFICIALLY OVER.
2. The probability of an EU structure collapse is under
appreciated by markets.
After Brexit, any
additional nation that leaves the EU will cause it to effectively end as an
ongoing concern. On December 4th, Italy will have a referendum on
"Constitutional Reform. A NO
vote will cause the loss of confidence in Prime Minister Matteo Renzi's power.
The trend is against the EU. More importantly there will be critical elections
of 2017, namely the French election of April 23-May 7th, where
front-runner Marine Le Pen wants to leave the EU. In The Netherlands, Greet Wilders is anti-EU
and very popular. There are also the German elections to be held August
22nd-October 22, with Angela Merkel now hugely unpopular. Many others also
occur in 2017 that will be important and each will be an effective referendum
for staying in or leaving the EU. The
2017 French election is critically important, as Manual Valls2
pointed out in a recent Financial Times editorial (on line subscription
required) titled The Push for Europe to Redefine Itself: "Let us face
facts: the European project is in trouble."
Note 2. Manuel Carlos Valls Galfetti
(born August 13, 1962) is a French politician who has been the Prime Minister
of France since March 31, 2014. He was
the Minister of the Interior from 2012 to 2014 and is a member of the Socialist
Party.
..
To buttress my contention that
Euro-socialism isnt working, consider a quote
from Vladimir Bukovsky, a Russian/USSR political
activist and dissident:
"Socialism is the gradual and
less violent form of Communism, and socialist is the project of the European
Union, which was born in Maastricht in 1992. The intent was to save socialism
in Europe after the fall of the Berlin Wall and the predictable bankruptcy of
the welfare state in the West as well."
Actually, its progressivism3
(not the socialism or the welfare state) thats the real problem.
Note 3. Progressivism is a philosophy based on the
idea of progress, which asserts that advancement in science, technology,
economic development, and social organization are vital to improve the human
condition. The meanings of progressivism
have varied over time and from different perspectives. The term is often used
now to denote a left wing way of looking at the world, as per this tutorial on the topic.
3. With an interest rate increase, a high likelihood exists
for a US (and global) recession in the first quarter of 2017.
Consumer spending is
likely to decline as a result of an interest rate increase. The U.S. consumer has added a minimum of $10
Billion to the consumer credit bubble for 50 months in a row. August was up $50 billion, the 4th largest
rise since 1950. Consumer credit is also
up $1.2 trillion since 2010, a rise of 46%.
Average credit card interest rates are 13% and rising because world
governments are talking of switching to additional fiscal spending (instead of
tax cuts) and even lower (and negative) interest rates, which have completely
failed to achieve their planned goals.
Curmudgeon Add-On
Comment:
The Federal Reserve
Bank of Cleveland recently published a very interesting research
paper which notes that fixed income spreads, which have previously been a
good indicator of a recession within 12 months, may no longer have predictive
power due to rates being so low for so long.
Instead, the metric proposed to predict future economic activity
proposed is the inflation-adjusted quarterly change in pre-tax corporate
profits.
As Ive been writing
for months now, the 3rd Quarter of 2016 marked the sixth
consecutive quarterly decline in corporate profits (source: FactSet). Hence, the US is way overdue for a recession
based on that economic indicator.
Ticking Time Bomb
Public Pensions in Crisis:
The most eerie future
monster problem was best described in a September 23rd IBD editorial. Heres an excerpt:
Insolvency: America's states, counties, cities and
municipalities are in deep trouble, owing literally trillions in public
employee pensions that they can't pay off. Nowhere is that more apparent than
in California, the nation's poster boy for fiscal irresponsibility.
All across America, bold pension promises were made,
premised on outsize returns in the stock market. When those returns didn't
occur and as spending on pensions soared, many pension funds became
insolvent. Today, state and local
pensions are nearly $2 trillion in the red, an amount that's expected to grow
in coming years.
To cover their benefits, pension funds need returns of 7.5%
or more. Unfortunately, as Elizabeth Campbell of Bloomberg News recently noted,
"public plans had a median increase of 1% for the year ended June 30, the
smallest advance since 2009." Without significant gains in coming years,
future taxpayers will be left holding the bag for bankrupt pensions denied
decent retirements themselves, but told that they still must pay for the overly
generous benefits of earlier generations.
This is a recipe for political crisis, and the risk of an
inter-generational political war is very real.
Victors Conclusions:
The equity markets are now in a calm
before the storm period. Markets are no
longer a one-way street reacting to the glib talk of central bankers (like the
ECBs Mario Draghi) saying theyll do whatever it takes. The Fed is in danger of losing all
credibility after much talk about rate hikes this year which havent
happened. They must raise rates in
December to save face. Other central
banks have reached their capacity limits (e.g. Japan and Europe) and will begin
to extricate themselves from their extraordinary reckless monetary
policies. The markets will be closely
watching.
As noted in this post, Libor rates
are way up, while long term bond prices have started a serious decline. It appears that the tide is turning and major
trends are reversing. The Curmudgeon and
I continue to believe that the next big move in the markets will be very
bearish for global equities and not at all friendly to bonds.
My theme for the economy and equity
markets is that theres a bad moon rising, as per Credence
Clearwater Revivals hit song from 1969. You can read the lyrics and hear
the music here.
Good luck and till next time...
The
Curmudgeon
ajwdct@sbumail.com
Follow the
Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been
involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a
historian, economist and financial innovator who has re-invented himself and
the companies he's owned (since 1971) to profit in the ever changing and arcane
world of markets, economies and government policies. Victor started his Wall Street career in 1966
and began trading for a living in 1968. As President and CEO of Alpha Financial
Technologies LLC, Sperandeo oversees the firm's research and development
platform, which is used to create innovative solutions for different futures
markets, risk parameters and other factors.
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