Weekend Reading: Recession Risk Rising

Lance Roberts  |

In yesterday’s post, we discussed the importance of the S&P 500 as a leading indicator of recessions in the U.S.

“The problem with making an assessment about the state of the economy today, based on current data points, is that these numbers are “best guesses” about the economy currently. However, economic data is subject to substantive negative revisions in the future as actual data is collected and adjusted over the next 12-months and 3-years. Consider for a minute that in January 2008 Chairman Bernanke stated:
‘The Federal Reserve is not currently forecasting a recession.’
In hindsight, the NBER called an official recession that began in December of 2007.”

My friend David Stockman from Stockman’s ContraCorner (a must-read site) sent me an email on Thursday morning stating:

“On your topic of today regarding recession recognition, here’s another point about after-the-fact revisions. NF payrolls were revised down by about 500,000 per month during the September-February 2008 plunge:”

The point here is that while CURRENT economic data points are positive, there are numerous ancillary data points which suggest the economy is already weakening. My colleague, Richard Rosso, sent me this note on the Fed’s alternative GDP calculation called GDP Plus:

“GDPplus is the Federal Reserve Bank of Philadelphia’s measure of the quarter-over-quarter rate of growth of real output in continuously compounded annualized percentage points. It improves on the Bureau of Economic Analysis’s expenditure-side and income-side measures. Currently, it is showing GDP at 4.0% annual growth with both GDI and GDP-Plus running at 2.0% or less.”

Historically, when GDP has deviated above both GDP-Plus and GDI, GDP has eventually “caught-down” with the rest of the data.

Currently, it is currently believed that the U.S. can remain an island of economic growth in a world struggling with weakness. As shown in the Ned Davis Research chart below, recession risk on a global scale has now surged above 70.

What does that mean?

“Readings above 70 have found us in recession 92.11% of the time (1970 to present). Several months ago, the model score stood at 61.3. It has just moved to 80.04. Expect a global recession. It either has begun or will begin shortly. Though no guarantee, as 7.89% of the time since 1970 when the global economic indicators that make up this model were above 70, a recession did not occur.” – Stephen Blumenthal

As we discussed yesterday, the dynamics of the market have now changed in a manner which suggests that “something has broken” in both the outlook for the economy and earnings.

While we have had corrections in the past, those corrections have not violated important long-term trends which have remained solidly intact since the 2009 lows. However, this past week, those violations began to occur. Over the long-term, trends are important to consider. The chart below shows the market versus a 75-week moving average. During bullish trends, the market trades above that average. During bearish trends, it’s the opposite.

With the market starting to violate that long-term support, it is worth paying attention to the risk of the market currently.

However, this does not mean you should “panic sell” the market currently. So far, this has been an expected, while painful, pickup in volatility as we discussed in our weekly missives. Most importantly, while the risks of a more meaningful mean reversion are rising, the market does not historically go straight up or down. Therefore, the change of the market’s tone from bullish to bearish does change the trading backdrop from buying dips to selling rallies.

Use rallies to reduce risk, rebalance portfolios, and raise cash for whatever happens next. If the market stabilizes, there are lots of great companies on “sale” currently. If the market declines further, you will appreciate the reduced volatility.

Just something to think about as you catch up on your weekend reading list.


Economy & Fed


Markets


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Research / Interesting Reads


“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected..” – George Soros

Questions, comments, suggestions – please email me.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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