Recession Coming Soon; Equities Bull Market Ending and Bear Growling
by Victor Sperandeo with the 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.
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.
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...
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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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