Money falling into a drain © LdF, Vetta, Getty Images

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.

Anthony Mirhaydari

Anthony Mirhaydari

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.

Real Nonresidential Investment

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.

Global Default Rates © Standard & Poor's

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.

LQD © StockCharts.com

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.

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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 anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.