ECRI U.S. Recession Forecast Will Weigh Heavily On Global Stock Markets

 |  Includes: AAPL, BAC, C, DIA, GS, INTC, MS, MSFT, PEP, QQQ, SPY, T, VZ, WFC
by: James A. Kostohryz
The Economic Cycle Research Institute (ECRI) is a firm that has garnered a great deal of publicity and acceptance in investment circles for its predictions related to the business cycle in the past few years.
On Friday, September 30th, ECRI went public for the first time with a bold prediction that the U.S. is heading into a recession, and that “there’s nothing that policy makers can do to head it off.”
I believe that this prediction will prove to be highly influential and will have an impact on equity markets (SPY, DIA, QQQ) in the coming weeks as ECRI spokesmen “pound the table” through the media in the next couple of weeks.
ECRI Handwriting Was On The Wall
In an article I published on August 15, 2011 entitled, “Leading Indicators May Signal Recession By September,” I discussed various leading indicator indices offered by various organizations that specialize in business cycle forecasting. I specifically signaled out ECRI as the organization that might be the first to “flip the switch,” and that they might do it as early as September.
This is what I wrote in my article:

ECRI. This one is the wild card. ECRI managing director, Lakshman Achuthan, has been loudly signaling a deceleration in the economy for several months. Most recently, he has stated that he believes that there will be a “double-dip recession scare,” although he does not know whether this will actually materialize into a recession. Apparently, ECRI indicators are heavily weighted toward financial markets indicators, and given the severe deterioration in most of these, it is likely that ECRI’s aggregate indicators will be significantly affected. Furthermore, there should be severe deterioration in other leading indicators of the real economy. ECRI has several indicators that they utilize, the well-known WLI being just one. Not only are these indicators proprietary, but nobody other than them really knows how they integrate them. There may be some element of subjectivity involved in the integration. Whatever the case may be, Achuthan has been signaling that he is essentially “on the fence” regarding whether he believes that there will be a recession. Recent events may very well push him over the edge and persuade him to make a recession call. If this happens it could cause waves.

Fast forward 45 days. In a statement on its Web site, ECRI writes:

Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off.

ECRI’s recession call isn’t based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down – before the Arab Spring and Japanese earthquake – to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not “soft landings.”

Last year, amid the double-dip hysteria, we definitively ruled out an imminent recession based on leading indexes that began to turn up before QE2 was announced. Today, the key is that cyclical weakness is spreading widely from economic indicator to indicator in a telltale recessionary fashion.

Why should ECRI’s recession call be heeded? Perhaps because, as The Economist has noted, we’ve correctly called three recessions without any false alarms in-between. In contrast, most of those who’ve accurately predicted a recession or two have also been guilty of crying wolf – in 2010, 2005, 2003, 1998, 1995, or 1987….

It’s important to understand that recession doesn’t mean a bad economy – we’ve had that for years now. It means an economy that keeps worsening, because it’s locked into a vicious cycle. It means that the jobless rate, already above 9%, will go much higher, and the federal budget deficit, already above a trillion dollars, will soar. 

Here’s what ECRI’s recession call really says: if you think this is a bad economy, you haven’t seen anything yet. And that has profound implications for both Main Street and Wall Street.
The U.S. Cannot Afford A Recession Right Now
I am not sure that I agree with ECRI quite yet about the inevitability of a recession. However, I agree with them wholeheartedly about one thing: The U.S. cannot afford a recession right now. I have written about this previously. I will review briefly:
The US has had many recessions in its history. According to the National Bureau of Economic Research (NBER), the most authoritative source of information regarding business cycles, there have been 11 recessions since 1945.
So what's the big deal if the U.S. has another one?
This historical moment is different. The US simply cannot afford a recession right now. Consider:
  • Millions of Americans are “under water,” barely hanging onto to their home mortgages. With their homes being worth less than what they owe on their mortgages, another recession would cause massive numbers of these “underwater” mortgage holders to definitively cease payments.
  • Given the still relatively fragile state of U.S. financial institutions such as Bank of America (NYSE:BAC), Citigroup (NYSE:C), Morgan Stanley (NYSE:MS) and Wells Fargo (NYSE:WFC), a general bankruptcy of the entire banking system could ensue from an acceleration of mortgage defaults. A collapse of the banking system would imply a U.S. recession on a scale unprecedented since the Great Depression.
  • The U.S. budget deficit currently exceeds 8% of GDP. Worse still, as a percentage of government revenues, the U.S. budget deficit is substantially higher than that of any of the PIIGS. A recession would imply a collapse of tax receipts. The projected budget deficit under such a scenario could easily balloon to more than 12% of GDP - simply not financeable by the private sector. Thus, the specter of either default or inflation would become inevitability. Again, the resulting general panic would trigger an economic crisis of unprecedented proportions.
  • Combined unemployment and underemployment is already more than 15%. A recession would likely push that figure above 20%. The specter of social unrest would become very real.
  • Unlike at any time since 1945 (the starting point for modern counter-cyclical macroeconomic policy management), the U.S. currently does not have the fiscal resources available nor is there enough political will to counteract the devastating economic and financial impacts that another recession would have at this particular time.
  • The nation is deeply divided and highly polarized politically. Populist right-wing demagogues spewing economically ignorant doctrines and hatred have proliferated. Left-wing labor-style militancy could surge at any moment. Historically, extremism and political violence has emerged from such a political and economic configuration. The economic and political atmosphere shares certain parallels with Weimar Germany or Pre-Peronist Argentina. Economic crisis and political polarization served as ideal breeding grounds for political and social conflict and the emergence of populist, extremist and ultimately anti-democratic national “saviors.”
ECRI has dropped a bomb. I believe that as the implications of their prediction start to sink in over the next few days, panic may start to spread in equity markets (^SPX, ^DJIA, ^IXIC, ^NDX).
My ultimate downside target for the S&P 500 remains at the 950-1,020 level, as I have been suggesting for almost two months now.
At that point, stocks such as Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC), AT&T (NYSE:T), Verizon (NYSE:VZ), Pepsi (NYSE:PEP) and Goldman Sachs (NYSE:GS) should be available for purchase at valuations that are even more attractive than they are right now.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.