Here Comes The Recession And Bear Market

Includes: DIA, IWM, QQQ, SPY
by: Bert Dohmen


The majority of analysts tell you that the 0.25% rate hike by the Fed is not important. They obviously know little about how the Fed works.

We warned in our December 2015 WELLINGTON LETTER: “Here comes the recession.” All the metrics we follow confirm that.

Our work suggests that in spite of the dubious 6.9% GDP growth reported by the China government, actual economic growth is less than zero.

Let me discuss one major error of most analysts you see in the media. It is about the Fed rate hike. There is a great misconception.

The majority of analysts tell you that the 0.25% rate hike by the Fed is not important. They obviously know little about how the Fed works.

But this is much more important than just a small rate hike. One has to know what it compels the Fed to do to achieve its goal. In order for the Fed to get the rate up to 0.25% from virtually zero, it has to drain reserves from the banking system. It does this via "reverse repos," which means it sells Treasuries to banks, and is paid via the bank's reserves. That means 'tightening' liquidity in the banking system.

On December 31, 2015, the Fed did almost $475 billion of reverse repos. Of course, this is not permanent, but usually measured in a few days or less. But it does reduce the ability of banks to lend to each other for that time. The above was a record amount, exceeding the prior record of $339.48 billion on June 30, 2014, 1.5 years ago.

On Jan 5, 2016 the fed did a reverse repo of almost $170 billion for one day.

The Fed has to continue doing this in order to keep the Fed Funds at or above 0.25%. Draining liquidity has always been considered negative for stocks.

Our "Theory of Liquidity & Credit," presented at the New Orleans Monetary Conference in 1977 for the first time, states that a rise in liquidity and credit leads to higher stock prices, and a reduction in those two leads to a declining stock market, often a bear market.

I called it "the secret key to the investment markets."

Don't take my words for the current 'tightening.' Here is what we stated in our newsletter:

E.D. Skyrm of Wedbush has done some calculations to determine what a 0.25% rate hike means. Mathematically, coming from zero, the hike is 'infinite' in percentage terms. Skyrm estimates that in a very rough estimate, the Fed needs to drain between $310B and $800B in liquidity. That's big.

According to our Theory of Liquidity and Credit we developed in the early 1970's, such a decline in liquidity could produce a severe stock market decline. The Fed is now risking being blamed for the up-coming recession, although that is already in the works, even without a rate hike. Yellen will go down in history as the person responsible for the next financial crisis.

All the metrics we follow confirm that, while the vast majority of analysts only quote the employment numbers, apparently not realizing that they are totally phony, by intent.

The employment report from December 4th stated that unemployment, the irrelevant U-3, stayed at 5%. Amazingly, it was greeted enthusiastically by commentators and the market. Allegedly, 211,000 jobs were created. As we wrote on that day in our trading services, the way part-time jobs are counted, even work at no pay is a "job." And if someone has had five such tasks in a month, even at no pay, it is counted as five jobs. (See the Dept. of Labor website).

Here is what economist John Williams of writes:

…the broader U.6 (unemployment) and ShadowStats' measures notched higher, to 9.9% and 22.9%, respectively. The headline 5.0% rate reflected more employed and unemployed, but with no jobs growth in full-time employment. All the employment gain was in part-time employment for economic reasons, with people seeking full-time jobs having to settle for available part-time work.

The ISM (Purchasing managers survey) showed this evidence of manufacturing contraction:

The Chicago PMI (Purchasing Managers Index) for November had a big plunge to 48.7 from 56.2 in October. Such a big decline is rare. When the ISM goes below 50, it has been followed by a recession 65% of the time.

We have warned about a sudden, sharp plunge in economic numbers for several months. Now the weakness we've discussed since the beginning of last year is surfacing. Soon Wall Street economists, who have been so cheerful, will no longer be able to ignore the signs.

Remember, we are NOT economists, and were not brainwashed at the university with Keynesian economics.

John Williams of ShadowStats wrote this about GNP:

headline growth in third-quarter 2015 gross national product (GNP) was just 1.27% in its initial reporting today. GNP is the broader measure of economic activity…

That's getting close to no growth.

The above only reviews some of the US numbers. The big pressure will come from a huge private sector recession in China, which will envelope Asia, and then the globe. About 50% of global GDP growth the past 15 years has come from China.

Our work suggests that in spite of the dubious 6.9% GDP growth reported by the China government, actual economic growth is less than zero.

China is the highest indebted country in the world, especially as a percentage of GDP. Private sector debt is over $30 TRILLION. That's almost twice the total US GDP. Therefore, the China recession will be followed by an immense credit crisis.

In a country which accounted for half of global growth, it is the ultimate folly to believe it won't have its effects on the rest of the globe.

Why is this important for investors? Look at the current chart of the RUSSELL 2000 index below, which is much broader than the indices usually shown. The top formation now is almost identical to other important market tops, including the top in 1929.

Click to enlarge

And then compare it to the 1929 CRASH. Note the important choppy, side-ways period followed by a brief upside breakout in both charts. That breakout had no follow-through. We call that a "false breakout." And that's not pretty for the bulls.

Click to enlarge

Of course, history doesn't have to repeat. But it often rhymes.

Conclusion: The US recession may already have begun. The Fed rate hike will turn out to be the greatest Fed error in memory, in a series of significant mistakes. The role of the Fed should be reviewed by Congress.

Disclosure: I/we 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.