12/19/2012 4:00 PM ET|
Welcome to the new recession
It may not have felt like it, but stocks have been in a 4-year bull market. That's coming to an end as a new recession nears -- and in fact, may already be here.
It may be hard to believe, but the bull market is turning four years old. And from the looks of things, it isn't going to make it to its fifth birthday.
That's because, despite the nice little Santa Claus rally Wall Street's been enjoying over the last few weeks and rising hopes of a "fiscal cliff" deal in Washington, some serious warning signs for both the market and the economy are emerging. In fact, one of the most respected economic forecasters in the business believes we're already in a new recession.
If true, now's no time for aggressive optimism. Instead, it's time to move to cash and batten down the hatches for what looks to be a rough 2013.
I'll explain why in a moment, but first, let's review how we got here.
Following the Fed
Just as a wintry chill was setting in, between Thanksgiving and Christmas 2008, the economy faced an imploding housing market and financial-system meltdown. At the Federal Reserve, desperate policymakers decided to start using freshly created dollars to buy mortgage securities. This drive, which came to be known as "quantitative easing" or QE1, was expanded in early 2009 to include Treasury bonds.
Corporate bonds, which have been an area of focus for the average investor this cycle, responded right away. Stocks, initially disappointed by President Barack Obama's election, found their footing in the spring, and the bull market was on. The economy didn't respond until the summer, while the job market took a full year to begin turning around.
The year that followed was promising until a government bond crisis in Dubai revealed that developed governments were overextended. Then, the impact of U.S. stimulus spending faded. That was followed by Greece kicking off the ongoing eurozone woes. Central banks kept the economic ball rolling with an alphabet soup of programs that all amounted to the same thing: more cheap money.
Things slowed, job growth leveled off, and stocks have pretty much been sliding sideways since the Fed ended its second round of quantitative easing, known as QE2, in mid-2011. Investors have pulled out since then. The U.S. economy is barely moving forward.
So while the Standard & Poor's 500 Index ($INX) climbed more than 120% from its March 2009 low to its September 2012 high, there is evidence that the current bull market has run its course.
And now, the drag
With rich-world governments collectively set to tighten their budgets by 1% of combined gross domestic product, according to the International Monetary Fund (1.3% here at home, worth nearly $180 billion next year) more weakness lies ahead.
This fiscal drag is already baked in. It could be made worse by any turmoil related to the process, from a fiscal cliff breakdown here at home to ongoing political tension in Europe or a bond market revolt in Japan.
What's scary about all this is that the recent slowdown has happened despite very aggressive action by the major central banks. The Fed is currently engaged in unlimited quantitative easing (QE3 plus QE4) of $85 billion a month, saying it will continue until the unemployment rate falls below 6.5% or the inflation rate rises above 2.5%. The European Central Bank has threatened unlimited bond purchases if a country -- such as Spain -- requests help and commits to a budget-cutting plan. Prime Minister-elect Shinzo Abe of Japan has said he will push the Bank of Japan to engage in unlimited bond-buying. The Bank of England is pushing hard, too.
It seems the global economy just isn't responding to cheap-money stimulus anymore as the credit channel remains constrained. Governments and households are focused on paying off debts, not borrowing more cheap money, while banks are busy rebuilding their capital reserves.
The stock market doesn't seem impressed, either: The Dow Jones Industrial Average ($INDU) actually finished with a loss on the day the Fed announced QE4 -- the first time stocks have moved lower in response to a new round of quantitative easing.
Welcome to the new recession
In fact, the folks at the Economic Cycle Research Institute, who have made some remarkably prescient calls on the business cycle over the last few decades, believe we are already in a recession that started in July.
Corporate executives have pulled back on capital expenditures in a big way, sending ripples throughout the supply chain. Industrial production is on a downward glide path despite a temporary lift from Superstorm Sandy rebuilding. Small-business confidence has collapsed. Personal income is down. All are consequences of the fact that real equipment and software spending -- a proxy for capital spending -- has suddenly sliced into recessionary territory.
According to UBS economists, the recent lift in the job market is at odds with this, which is one reason I've been hammering on about the questionable veracity of the recent drop in the unemployment rate to 7.7%. A better measure of the job market, the employment-to-population ratio, is flat-lining near early 1980s levels. The disconnect is illustrated in the chart above.
Surprise, surprise. The drop in corporate investment and overall stupor of the global economy is starting to negatively impact corporate earnings -- which had been a rare bright spot over the past few years, thanks to strong foreign demand (from consumers in emerging-market nations) and the ability to make deep, harsh cuts to the jobs, wages and benefits offered to American workers.
You can see this in the way unit labor costs -- a measure of labor expense -- have stalled near prerecession levels despite the fact the economy has grown $312 billion over its prerecession peak to help push corporate profits to record highs.
That is what threatens the bull market.
Growth gets hard to find
Barclays Capital equity strategist Barry Knapp notes that corporate earnings and revenue trends are at typical prerecession levels. Heading into the Q3 reporting season, the S&P 500 had posted 12 consecutive quarters of earnings growth since the financial crisis. However, that run is under threat as third-quarter earnings have grown just 0.1% over past year.
Revenue is under pressure, with just 40% of companies reporting top-line growth above analyst expectations, which is lower than the long-term average of 62% and lower than the 55% average of the past four quarters. Heading into Q4, there have been 96 negative earnings preannouncements, compared with just 27 positive ones, a ratio of 3.6 versus an average of 2.3 since 1995.
We'll know more soon as Alcoa (AA) kicks off Q4 earnings season with its profit report on Jan. 8, 2013.
Historically, negative earnings growth has been a perfect corollary to economic recessions. So, if we are indeed already in a downturn, it should be reflected in an outright drop in fourth-quarter earnings versus the fourth-quarter of 2011 results.
The bad news on bonds
While investors have largely shunned stocks in this bull market, they have piled wholeheartedly into corporate bonds -- pushing the yields, on some high-quality paper to levels below those on Treasurys. Some major U.S. corporations can now borrow at cheaper rates than the federal government can.
The narrowing of the "spread" or the difference in rates between corporate bonds and Treasurys is a reflection of people's lowered expectations that negative events, such as default or bankruptcy, will happen. This isn't surprising, given impressive earnings growth coming out of the last recession.
But should the economy and earnings weaken -- as I expect -- the corporate bond default rate should pop back up as it has during recent recessions. That will pressure bond prices and shatter the illusion of fixed-income investments as a haven from any storm.
The Bank for International Settlements warned of this in its latest quarterly report, noting that some asset prices have "started to appear highly valued in historical terms relative to indicators of their riskiness." For instance, global high-yield corporate bond spreads over government bonds have fallen to levels comparable to those of late 2007 as the last bull market was peaking, yet the default rate on these bonds is now running around 3% versus a rate near 1% then.
In other words, we could be looking at the type of irrational exuberance that typifies bull market tops. Only this time, it's concentrated in the corporate bond market.
Certainly, everyday investors are exposed. According to data from the Investment Company Institute, retail money market funds are currently at $629 billion. That's below the mid-2000s bull market lows. It's territory that hasn't been seen since the late 1990s. So people are extended and carrying relatively small cash balances.
The chart above shows how bonds have solidly outperformed equities since 2007, falling less than stocks during the 2008-2009 wipeout and nearly keeping pace with the stock market's post-recession gains. It's been an impressive run: While stocks are only now returning to their early 2007 levels, investment-grade bonds are up more than 50% over the same period.
But like all things, this will come to an end. And based on the evidence I see, it could come sooner than many expect. Already, it looks as if cyclical, economically sensitive stocks topped out in early 2011 and have been in the doldrums since. The broad market has set marginally higher highs since then, thanks to the heroic effort of the technology sector, along with a shift into more-defensive areas such as consumer staples.
The same shift happened as the last bull market was waning in 2007 and 2008. It's taking a little longer this time, but the behavior looks remarkably similar.
It's time for the prudent to move into cash or real assets. Given the combined shock of fiscal austerity, the realization the Fed can't prevent all financial ailments, rising corporate default rates, and another bout of rising joblessness, 2013 could be a nasty year. I guess it's time for a dose of triskaidekaphobia -- fear of the number 13.
At the time of publication, Anthony Mirhaydari did not own or control shares of any company mentioned in this column in his personal portfolio.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at email@example.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
VIDEO ON MSN MONEY
Steps to a lasting and thriving economy:
1) Stop lifetime benefits for part time politicians.
2) 25% penalty tax on any item not made in the USA
3) Limited time available to draw welfare
4) Reimplementation of the CCC for any able bodied person on Government assistance.
5) Temporarily suspend the right to vote for any able bodied person drawing government assistance.
6) Regulated pricing on Gas, Utilities, Food and Health Care.
7) Limit foreign aid.
8) Flat 15% Federal income tax on everyone, NO deductions, NO exemptions.
9) Balanced Federal Budget or all politicians forfeit their pay.
We have a president and government that can't fix a economy that has been suffering for almost six years now, but they can pass a gun control law in six weeks!? Go figure!!
This should not come as a surprise. I'm waiting for farmland values to crash, talk about unsustainable. $10,000 or more per acre of farmland? Insanity.... The next drought may speed that along.
If they want to fix our "the peoples" money troubles........ Get the gas prices down to a dollar a gallon. you will see a turn around begin in one month.
Well, Why does the U.S. and foreign countries base everything off of Stock Market performance ?
Did we not learn from the 1929 Crash and went into the Great Drepession. The only reason the Great Depression disolved cause we entered WW II.
Wall Street has destroyed this Great Country along with a long list of corrupt people that I will name.
CEO's, Bank Presidents, Politicans, Lawyers, Large Corporations, Mafia/Syndicates/Drug Lords, Schemers, and many more reasons which also includes our own U.S. Government committing "Fraud, Waste and Abuse".
As those of you who elected Barack Obama in 2008, who can thank Obama for the STIMULUS PACKAGE that bailed out the Crooks and gave us more Worthless Printed Dollars as the value of American Currency plunged and gave us our worst Credit Rating then onto an Increase of Raising the Debt roof leading us to the Fiscal Cliff.
Remember this, the Obama Administration FAILED the people as Obama wanted the U.S. to crumble and become a Socialist nation. Obama and his hoodlums of Evil are in Part 2 of their wicked plan since you've re-elected him in 2012.
We never left the Recession of 2008 and here we are buried in the Greatest Despression the World will ever know.
The Liberal / Democrats put us in this situation the last 2 years when they held the chips in the Senate/Congress/ House of Representatives during the BUSH Administration. It was not the Republicans that caused the Recession but the Democrats fearing that the Republicans would dominate.
As you will notice the only happy people are the Wealthy and those in Power. Hopefully GOD will punish them along with Obama.
The people need to retake our Government and make it work for the people. Also to demolish/ rid of Wall Street as those who support it are very GREEDY.
And therein lies the problem. Corporations continue to rake in RECORD profits while more and more regular Americans slip further into poverty. If Americans can't afford your products, how do you expect sustainable future revenue? Workers are laid off, wages are stagnant, the Average Joe is going nowhere while those at the top line their pockets some more, even though they have more money than they can spend. And I'm not advocating the old "tax the rich" line.
Corporations need to be penalized for shipping American jobs overseas. They need to pay taxes. Why are companies making record profits not paying taxes? Why are companies making record profits being given taxpayer money in the form of subsidies?
I'm not advocating the end of capitalism. People and companies have every right to make money. An ethical company though, if they are already profitable, doesn't lay off thousands of people simply to drive the bottom line up a little more. An already profitable ethical company doesn't continue to raise prices on their goods when so many Americans are hurting just to drive the bottom line up a little more.
Making money is fine. Being an uncaring, unethical piece of crap who rapes America for everything you can take, isn't.
So what else is new? We the 99% have been in a / the recession since 2008. To me it's still a depression, only because of the length of time involved.
Let's talk about the "Cliff" that we're about to go over. Those in Washington want us to go over. It means more tax dollars for them. Why else do all the bozos in Washington stand around and blame the other guy for not doing the right thing. I would be very happy to lose the Bush tax breaks. Every time he put one through, I can home with less money in my check. Never could figure out how a tax break reduced my net pay. Just as a note, I live on the border between working poor and poverty.
I think what has happened in Washington is government by the lobbyists. It doesn't work, never will.
Our markets oversold during the crash of 2007-2009. Our growth, to the extent we have growth, has come about because of trillions in deficit spending and cash printing. We've spent MANY trillions at this point and haven't improved real wealth values by the amount spent. Translation: We are less wealthy than before all this charade began, but because as a people we are about as economically illiterate as a population ever could be, we don't get why, or how. We just trade our votes for the promise of more free stuff.
We need major tax code reforms to simplify the entirety of the code. We need to reduce (I'd eliminate) the business tax. We need major entitlement reform--SS, Medicare, and Medicaid to be sure. We need a rollback of the tens of thousands of pages of regulations that have been promulgated. We may need other things too, but this is a start. We are in deep kimshee, and not until we quit trying to delude ourselves with deficit spending to pay for stuff we want today and think we are doing something right will we be able to get on the right path again.
Our economy is fundamentally sick. We need to go back to fundamentals and completely eschew DC as our economic savior. DC can't find its way out of an economic bag, it sure as heck can't help the rest of us.
Whenever you read incindiary "I-Reporting" crap like this just think weathermen: they can measure a thing - but don't confuse that with an ability to understand, let alone control, the thing they can measure.
Do your own homework. Be clear on what you are willing to risk. Be contet to play smallball and take your opportunities where you can find them. Sometime you just don't make a bunch of birdies in your round - take your par and get outta there.
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