The Case for Recession Strengthens 4 comments
John Bougearel
About this author:
-
Font Size:
-
Print
- TweetThis
U.S. Economic data in the first week of the New Year spelled T-R-O-U-B-L-E for
both the US economy and the stock market. The December ISM report on
January 2nd showed the manufacturing sector joining the housing and
financial sectors already in recessionary territory.
Then on January 4th the NFP report showed only 18,000 jobs were created in December and the unemployment rate jumped 0.3% in one month – also consistent with an economy slipping into recessionary territory. “The last time the jobless rate rose by this much in a single month was in the second half of 2001, when the economy was in the teeth of a recession” said economy.com.
``Since 1949 the unemployment rate has never risen by this magnitude without the economy being in recession,'' said John Ryding, chief economist at Bear Stearns.
RBS’s chief economist Stephen Stanley said in a note to his clients that “we are spooked by this week’s data…[and] a collapse in consumer spending last month would prompt him to carve up our forecasts for 2008 and start over with much weaker growth estimates.”
Economy.com notes that the "magnitude of the spike in unemployment over the past year with December's 0.3% increase has now risen 0.33% on a three month moving average basis from its low. Historically, [since the post WW II era] this has been an accurate predictor of recession...the point where negative feedback loops have kicked in...weaker final demand begets less hiring and investment, further restraining final demand."
The SP500 as a result plunged 4.1% in the first week of the New Year and settled 10.2% below its peak valuations set on October 11th. The question at hand is how much has the stock market already discounted the increasing probability of recession and will the bull campaign in the stock market come to an end? A signal that the bull market has come to an end would be to see the stock market close below its August 2007 lows at 1375 (3.3% below the Jan 4 closing price) and take out last years lows at 1364 (4.1% below Jan 4’s closing price).
According to a Bloomberg on January 2nd, “The steepest year end slump in global stocks since 2000 left equities with the cheapest valuations in more than 30 years” suggests that even if the economy slips into a recession that the stock market has discounted most of that probability. If that is the case, then sustaining a trade below 1375 and 1364 will likely prove very difficult in the near term (let’s say in 1H 08). That also implies that any shift from bull market to bear market may also prove to be a short-lived phenomenon.
“Don’t Fight the Fed, You Just Might Win!”
Investors should note that if the US does fall into a recession, most market participants concur that there is very little the Fed can do about it now. "If we're going to have a recession, it's too late to do anything about it. The Fed can't prevent a recession if one's in the making, and we're pretty close'' said Stuart Schweitzer, global strategist at JPMorgan.
In other words, the Wall Street axiom “Don’t Fight the Fed” is proving to be nothing but a bucket with a big hole in the bottom – for the second time this decade! (See my published article "Don't Fight the Fed, You Just Might Win" in the Sept 2001 Futures magazine).
Monetary policy, we all know works with a lag. The Fed can either be "ahead of the curve" i.e. pre-emptive or "behind the curve." In Jan 2001, they saw something they did not like and they acted pre-emptively with rate cuts. Even with this pre-emptive strike, we still ended up experiencing a mild recession and neither the economy nor the stock market picked up until 18 months later after the Iraq war in the spring of 2003.
Hawkish Fed Turns Dovish at the December 11 FOMC meeting
In 2007, the Fed did not act pre-emptively because they were and still are cognizant of the inflationary pressures in the economy (remember crude oil has been trending higher from $49.90 on Jan 18 2007 to a record $100 one year later as of Jan 3 2008).
According to the Fed through the October 31st FOMC meeting, risks to economic growth were on balance “roughly equal” or skewed to the upside. It wasn't until the December 11th FOMC meeting that risks to economic growth shifted from "roughly equal" to the downside. Thus, it has only been in the past several weeks that the hawkish Fed has taken a more dovish stance in their statements saying that downside risks to economic growth are clearly trumping their concerns regarding inflationary pressures.
As I write, the SP500 continues to weaken, strengthening the case that the equity bull market may be ending. With that in mind, it is time to take a close-up look at the damage being inflicted on the index (see chart below). First, the active 434 day moving average (in green) which provided support to the SP500 in June and July 2006 and August and November 2007 is beginning to show signs of failing. A close below the 434 (at 1417.50) moving average hasn’t happened to the SP500 since August 2003.
Secondly, there is substantial evidence on the SP 500 chart that all monetary tools being employed to save the stock market are failing. In other words, if you have been fighting the Fed since the second half of 2007, you are now pretty much winning the game at this point in time.
Yes, the SP500 is still above the August 16th low, but it is below the August 17th low at 1425 when the Fed cut the discount rate 50 bps. The SP500 is also well below the Sept 18 2007 low at 1479 when the Fed also cut the fed funds rate 50 bps. Investors were decidedly unhappy with the 25 bps rate cuts on Oct 31st and again on December 11th as the rallies into both those dates failed. In fact, each FOMC date since the October 11 2007 peak in the SP500 has set a lower high signaling investor confidence is diminishing with each passing FOMC meeting (the next one is on January 30th).
A failure of the Monday November 26th low at 1407 would be yet another signal investor confidence in the Fed continues to erode. That low was set when the Fed mentioned “heightened pressures” evolving in the money markets had forced their hand into creating the Term Auction Facility (TAF) which commercial banks and other lenders could tap to meet their year end funding needs in the "Shadow Banking System." A failure of the Nov 26 low would be the second indication that the Term Auction Facility is proving insufficient to keep the equity markets afloat. It would also set the stage for the stock market to signal a shift from bull to bear (a bear market is defined as setting lower highs and lower lows).
For the balance of January, investors may wish to remind themselves of two things. First, investors should note that the low in November was set during the week of the 1st round of auctions at the TAF and that the high in December was set on the FOMC meeting. If a similar thread plays out in January, then the stock market should be expected to trade lower until the next auction at the TAF on Monday January 14th and Friday January 18th. That week, will also kick off the Q4 earnings season which the stock market has been discounting since analysts began doing Q4 revisions for the financials in early November. As a result, the stock market can be said to have been bracing themselves for a Q4 07 earnings recession since early November. Therefore the week of January 14th makes for an excellent week for the stock market to set a short term low, or to stage some sort of relief rally into the end of January.
Secondly, if the SP 500 indeed sets a low in the week of Jan 14th or before, the stock market may well be able to rally into month’s end when the next FOMC meeting will announce the next rate cut of 25 or 50 bps. If investors are unhappy with either the size of the rate cut or the FOMC statement and subsequent economic data remains decidedly bearish, they should expect another short term high in the stock market will form around the time of the FOMC meeting the end of January. It things have indeed turned bearish, a rally into the Jan FOMC meeting may be the only exit strategy afforded investors until the Q1 08 earnings beginning in April 2008.
The Clock Analogy
The 2007 chart of the SP 500 has taken on the appearance of a clock. Back in June and July, the stock market had reached the twilight of its bull campaign when Bear Stearns two hedge funds blew up. That was the stock markets “11th hour.” The final stroke of midnight was reached on October 11th, when the financial stocks fell into an earnings recession. Three months later, we find the manufacturing sector falling into a recession and jobs simultaneously cratering in December 2008. As we enter the Q4 07 earnings season, we find the SP500 positioned around 3:00 o’clock. At this rate, the SP500 won’t reach 6:00, or the bottom of the clock until April 2008, when Q1 2008 earnings are being reported. If the clock analogy holds the SP500 may set its lows for the year in Q2 2008.
click to enlarge
This of course still leaves unanswered how low will the stock market go near term and how low it will ultimately go in the 1st half of 2007. Tackling those questions will be the subject of other reports. As of now, we have a double bottom at the onset of the second week of January 2008 at the November 2007 lows.
***Author's Postscrtipt Note - this report may be considered inconsistent with earlier reports I wrote on Zweig's monetary supermodel bull signal being elected on the Sept 18 2007 fed funds rate cut - the only indicator Zweig says you will ever need. Last week's 4.1% SP500 correction on recessionary data took the SP500 out of super bull mode based on Zweig's supermodel on monetary easing (remember a greater than 4% correction in any one week nullifies the bull signal in the Zweig model and you start over more or less - so this report is actually still consistent with the Zweig model).
In short, the weakening economic data pointing to a recession indicates the Fed has fallen a bit behind the curve on its monetary policy. Thus the weakness in equities had not been fully discounted by the time of the first fed funds rate cut on September 18 2007. This accounts for why the SP500 is more than 3% below the Sept 18 fed funds rate cut low today almost 4 months later.
Postscript reply to a question from market speculator at trading goddess' blogsite who asked :
mkt spec: Unemployment sits at 5%...just off the top of my head, isn't that on the lower end of the avg?"
Me: mkt spec,
Good question,
This is the highest unemp has been since 5.1% in Sept 2005. Labor conditions were tightest this decade at 3.8% in April 2000, just after the stock market peaked. The 6.3% peak slack in employment this decade in June 2003.
So, we are actually 1.2% off the trough unemp rate, and 1.3% off the peak unemp rate this decade.
And it isn't necessarily where we are on the unemployment spectrum that is alarming economists, it's the rate of change and acceleration in the rate that has them up in arms since the rate bottomed at 4.4% in March 2007.
Then on January 4th the NFP report showed only 18,000 jobs were created in December and the unemployment rate jumped 0.3% in one month – also consistent with an economy slipping into recessionary territory. “The last time the jobless rate rose by this much in a single month was in the second half of 2001, when the economy was in the teeth of a recession” said economy.com.
``Since 1949 the unemployment rate has never risen by this magnitude without the economy being in recession,'' said John Ryding, chief economist at Bear Stearns.
RBS’s chief economist Stephen Stanley said in a note to his clients that “we are spooked by this week’s data…[and] a collapse in consumer spending last month would prompt him to carve up our forecasts for 2008 and start over with much weaker growth estimates.”
Economy.com notes that the "magnitude of the spike in unemployment over the past year with December's 0.3% increase has now risen 0.33% on a three month moving average basis from its low. Historically, [since the post WW II era] this has been an accurate predictor of recession...the point where negative feedback loops have kicked in...weaker final demand begets less hiring and investment, further restraining final demand."
The SP500 as a result plunged 4.1% in the first week of the New Year and settled 10.2% below its peak valuations set on October 11th. The question at hand is how much has the stock market already discounted the increasing probability of recession and will the bull campaign in the stock market come to an end? A signal that the bull market has come to an end would be to see the stock market close below its August 2007 lows at 1375 (3.3% below the Jan 4 closing price) and take out last years lows at 1364 (4.1% below Jan 4’s closing price).
According to a Bloomberg on January 2nd, “The steepest year end slump in global stocks since 2000 left equities with the cheapest valuations in more than 30 years” suggests that even if the economy slips into a recession that the stock market has discounted most of that probability. If that is the case, then sustaining a trade below 1375 and 1364 will likely prove very difficult in the near term (let’s say in 1H 08). That also implies that any shift from bull market to bear market may also prove to be a short-lived phenomenon.
“Don’t Fight the Fed, You Just Might Win!”
Investors should note that if the US does fall into a recession, most market participants concur that there is very little the Fed can do about it now. "If we're going to have a recession, it's too late to do anything about it. The Fed can't prevent a recession if one's in the making, and we're pretty close'' said Stuart Schweitzer, global strategist at JPMorgan.
In other words, the Wall Street axiom “Don’t Fight the Fed” is proving to be nothing but a bucket with a big hole in the bottom – for the second time this decade! (See my published article "Don't Fight the Fed, You Just Might Win" in the Sept 2001 Futures magazine).
Monetary policy, we all know works with a lag. The Fed can either be "ahead of the curve" i.e. pre-emptive or "behind the curve." In Jan 2001, they saw something they did not like and they acted pre-emptively with rate cuts. Even with this pre-emptive strike, we still ended up experiencing a mild recession and neither the economy nor the stock market picked up until 18 months later after the Iraq war in the spring of 2003.
Hawkish Fed Turns Dovish at the December 11 FOMC meeting
In 2007, the Fed did not act pre-emptively because they were and still are cognizant of the inflationary pressures in the economy (remember crude oil has been trending higher from $49.90 on Jan 18 2007 to a record $100 one year later as of Jan 3 2008).
According to the Fed through the October 31st FOMC meeting, risks to economic growth were on balance “roughly equal” or skewed to the upside. It wasn't until the December 11th FOMC meeting that risks to economic growth shifted from "roughly equal" to the downside. Thus, it has only been in the past several weeks that the hawkish Fed has taken a more dovish stance in their statements saying that downside risks to economic growth are clearly trumping their concerns regarding inflationary pressures.
As I write, the SP500 continues to weaken, strengthening the case that the equity bull market may be ending. With that in mind, it is time to take a close-up look at the damage being inflicted on the index (see chart below). First, the active 434 day moving average (in green) which provided support to the SP500 in June and July 2006 and August and November 2007 is beginning to show signs of failing. A close below the 434 (at 1417.50) moving average hasn’t happened to the SP500 since August 2003.
Secondly, there is substantial evidence on the SP 500 chart that all monetary tools being employed to save the stock market are failing. In other words, if you have been fighting the Fed since the second half of 2007, you are now pretty much winning the game at this point in time.
Yes, the SP500 is still above the August 16th low, but it is below the August 17th low at 1425 when the Fed cut the discount rate 50 bps. The SP500 is also well below the Sept 18 2007 low at 1479 when the Fed also cut the fed funds rate 50 bps. Investors were decidedly unhappy with the 25 bps rate cuts on Oct 31st and again on December 11th as the rallies into both those dates failed. In fact, each FOMC date since the October 11 2007 peak in the SP500 has set a lower high signaling investor confidence is diminishing with each passing FOMC meeting (the next one is on January 30th).
A failure of the Monday November 26th low at 1407 would be yet another signal investor confidence in the Fed continues to erode. That low was set when the Fed mentioned “heightened pressures” evolving in the money markets had forced their hand into creating the Term Auction Facility (TAF) which commercial banks and other lenders could tap to meet their year end funding needs in the "Shadow Banking System." A failure of the Nov 26 low would be the second indication that the Term Auction Facility is proving insufficient to keep the equity markets afloat. It would also set the stage for the stock market to signal a shift from bull to bear (a bear market is defined as setting lower highs and lower lows).
For the balance of January, investors may wish to remind themselves of two things. First, investors should note that the low in November was set during the week of the 1st round of auctions at the TAF and that the high in December was set on the FOMC meeting. If a similar thread plays out in January, then the stock market should be expected to trade lower until the next auction at the TAF on Monday January 14th and Friday January 18th. That week, will also kick off the Q4 earnings season which the stock market has been discounting since analysts began doing Q4 revisions for the financials in early November. As a result, the stock market can be said to have been bracing themselves for a Q4 07 earnings recession since early November. Therefore the week of January 14th makes for an excellent week for the stock market to set a short term low, or to stage some sort of relief rally into the end of January.
Secondly, if the SP 500 indeed sets a low in the week of Jan 14th or before, the stock market may well be able to rally into month’s end when the next FOMC meeting will announce the next rate cut of 25 or 50 bps. If investors are unhappy with either the size of the rate cut or the FOMC statement and subsequent economic data remains decidedly bearish, they should expect another short term high in the stock market will form around the time of the FOMC meeting the end of January. It things have indeed turned bearish, a rally into the Jan FOMC meeting may be the only exit strategy afforded investors until the Q1 08 earnings beginning in April 2008.
The Clock Analogy
The 2007 chart of the SP 500 has taken on the appearance of a clock. Back in June and July, the stock market had reached the twilight of its bull campaign when Bear Stearns two hedge funds blew up. That was the stock markets “11th hour.” The final stroke of midnight was reached on October 11th, when the financial stocks fell into an earnings recession. Three months later, we find the manufacturing sector falling into a recession and jobs simultaneously cratering in December 2008. As we enter the Q4 07 earnings season, we find the SP500 positioned around 3:00 o’clock. At this rate, the SP500 won’t reach 6:00, or the bottom of the clock until April 2008, when Q1 2008 earnings are being reported. If the clock analogy holds the SP500 may set its lows for the year in Q2 2008.
click to enlarge
This of course still leaves unanswered how low will the stock market go near term and how low it will ultimately go in the 1st half of 2007. Tackling those questions will be the subject of other reports. As of now, we have a double bottom at the onset of the second week of January 2008 at the November 2007 lows.
***Author's Postscrtipt Note - this report may be considered inconsistent with earlier reports I wrote on Zweig's monetary supermodel bull signal being elected on the Sept 18 2007 fed funds rate cut - the only indicator Zweig says you will ever need. Last week's 4.1% SP500 correction on recessionary data took the SP500 out of super bull mode based on Zweig's supermodel on monetary easing (remember a greater than 4% correction in any one week nullifies the bull signal in the Zweig model and you start over more or less - so this report is actually still consistent with the Zweig model).
In short, the weakening economic data pointing to a recession indicates the Fed has fallen a bit behind the curve on its monetary policy. Thus the weakness in equities had not been fully discounted by the time of the first fed funds rate cut on September 18 2007. This accounts for why the SP500 is more than 3% below the Sept 18 fed funds rate cut low today almost 4 months later.
Postscript reply to a question from market speculator at trading goddess' blogsite who asked :
mkt spec: Unemployment sits at 5%...just off the top of my head, isn't that on the lower end of the avg?"
Me: mkt spec,
Good question,
This is the highest unemp has been since 5.1% in Sept 2005. Labor conditions were tightest this decade at 3.8% in April 2000, just after the stock market peaked. The 6.3% peak slack in employment this decade in June 2003.
So, we are actually 1.2% off the trough unemp rate, and 1.3% off the peak unemp rate this decade.
And it isn't necessarily where we are on the unemployment spectrum that is alarming economists, it's the rate of change and acceleration in the rate that has them up in arms since the rate bottomed at 4.4% in March 2007.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 4 comments:
The question now, since the inflation rate is criminally understated by 2.5%, making inflation easily 5%, is Bernanke going to lower the cost of money drastically lower than inflation, to reflate the economy again, bailing out the top 5% investor -class while further crushing average saving Americans and seniors with hyperinflation?
I also expect CNBC to trot out the "deflation" crowd soon, in desperation.