U.S. Could Enter Recession In May

 |  Includes: SPY
by: Greedometer

Yesterday, the Federal Reserve Bank of Chicago released its January National Activity Index - an excellent barometer of national economic health. The report made large upward revisions to previous estimates of November and December. So I expect an upward revision to Q4 2012 GDP from the previous -0.1% to something like +0.5% to be announced by the BEA at some point.

As of October 2012, the rolling sum of Chicago Fed index data was -2.3. The previous recession began when the Chicago Fed index saw a rolling sum of -2.42. So we probably flirted with a flat-lining economy in Q4, but probably not outright contraction.

These graphs show a rolling monthly reading of 3-month averages. The "economic damage" is a sum of the rolling monthly values beginning with an initial month exhibiting negative readings. (In mathematical parlance, the red area on the graph is the integral of the function. You knew that grade 12 math was going to come in handy at some point.)

(click to enlarge)Chicago Fed NatClick to enlarge

FYI: I expect the economy to stagnate in Q1 2013, and begin to contract in Q2 as the effects of fiscal contraction begin to take their toll. Here's my forecast for the Chicago Fed index. (January is the last known point on the graph, the rest are estimates.)

(click to enlarge)Chicago Fed Index estimate early 2013Click to enlarge

Much has been made of the stock market's ability to see the future. If the above recession estimate is close to correct (May 2013), then it would be reasonable to expect the stock market to top-out in the February-April timeframe. You might also expect a leading stock market risk indicator to be showing a warning sign in February.

How could investors prepare? If you don't have the stomach to tolerate another 50%+ haircut in your stock portfolio, perhaps you could consider the same move as corporate insiders were doing in a panic last week: sell your risk assets into any rallies that come along over the next couple months. You could consider safe haven assets (short term high quality corporates, short term Tnotes, short term international sovereign notes, bank CDs, or even parking in cash). It won't pay much. That misses the point. Sometimes the main thing is to avoid losing big, and having ready capital to deploy when there's blood in the streets. And I'm sorry to write, there almost certainly will be in 2014.

What could mess up this forecast?

  • Another massive Fed intrusion - or threat of intrusion. The Fed is already all-in with QE3 and QE4. It could threaten to expand the program further. That could potentially instill some confidence. Or it could backfire. At some point more currency printing is going to be interpreted as confirmation that we cannot escape an ugly reality.
  • The US Congress could chicken out on implementing fiscal tightening. They're proven adept at this.
  • It's possible the ECB threatens to expand OMT. But given the lack of political will to undertake the required concessions, I don't see how the ECB could extend its balance sheet further.
  • The PBoC is already doing what they can to stoke their economy. Perhaps they are able to do more without driving inflation. Perhaps.
  • The BoJ already has the throttles pegged wide open with an epic QE program.

Food for thought.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.