Tag Archives: Recession

Zillow: The Next Recession is Two Years Away

The next U.S. recession is likely to begin in the first quarter of 2020

The next U.S. recession is likely to begin in the first quarter of 2020, according to a poll of 100 economists published Zillow’s Home Price Expectations Survey for the second quarter.

More than half of the survey respondents pointed to monetary policy as the likeliest cause for the next downturn, with only nine of the polled economists predicting that the housing market will be the cause of the next crash. Indeed, most of the economists predicted home values will rise 5.5 percent in 2018 to a median of $220,800. But if the Federal Reserve raises rates too quickly, the economists warned, the economy will start to slow and that could spur a new recession.

“As we close in on the longest economic expansion this country has ever seen, meaningfully higher interest rates should eventually slow the frenetic pace of home value appreciation that we have seen over the past few years, a welcome respite for would-be buyers,” said Zillow Senior Economist Aaron Terrazas. “Housing affordability is a critical issue in nearly every market across the country, and while much remains unknown about the precise path of the U.S. economy in the years ahead, another housing market crisis is unlikely to be a central protagonist in the next nationwide downturn.”

https://nationalmortgageprofessional.com/sites/default/files/Recession_Chart_05_22_18.png

Source: National Mortgage Professional Magazine

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A Liquidity Crisis Of Biblical Proportions Is Upon Us


Authored by John Mauldin via MauldinEconomics.com,

Last week, I mentioned an insightful comment my friend Peter Boockvar—CIO of Bleakley Advisory Group—made at dinner in New York: “We now have credit cycles instead of economic cycles.”

That one sentence provoked numerous phone calls and emails, all seeking elaboration. What did Peter mean by that statement?

In an old-style economic cycle, recessions triggered bear markets. Economic contraction slowed consumer spending, corporate earnings fell, and stock prices dropped. That’s not how it works when the credit cycle is in control.

Lower asset prices aren’t the result of a recession. They cause the recession. That’s because access to credit drives consumer spending and business investment.

Take it away and they decline. Recession follows.

https://www.zerohedge.com/sites/default/files/inline-images/Image_1_20180516_ME_OP_JM_LiquidCrisis.jpg?itok=kM8j--Ei

The Debt/GDP ratio could go higher still, but I think not much more. Whenever it falls, lenders (including bond fund and ETF investors) will want to sell. Then comes the hard part: to whom?

You see, it’s not just borrowers who’ve become accustomed to easy credit. Many lenders assume they can exit at a moment’s notice. One reason for the Great Recession was so many borrowers had sold short-term commercial paper to buy long-term assets.

Things got worse when they couldn’t roll over the debt and some are now doing exactly the same thing again, except in much riskier high-yield debt. We have two related problems here.

  • Corporate debt and especially high-yield debt issuance has exploded since 2009.
  • Tighter regulations discouraged banks from making markets in corporate and HY debt.

Both are problems but the second is worse. Experts tell me that Dodd-Frank requirements have reduced major bank market-making abilities by around 90%. For now, bond market liquidity is fine because hedge funds and other non-bank lenders have filled the gap.

The problem is they are not true market makers. Nothing requires them to hold inventory or buy when you want to sell. That means all the bids can “magically” disappear just when you need them most.

These “shadow banks” are not in the business of protecting your assets. They are worried about their own profits and those of their clients.

Gavekal’s Louis Gave wrote a fascinating article on this last week titled, “The Illusion of Liquidity and Its Consequences.” He pulled the numbers on corporate bond ETFs and compared them to the inventory trading desks were holding—a rough measure of liquidity.

Louis found dealer inventory is not remotely enough to accommodate the selling he expects as higher rates bite more.

We now have a corporate bond market that has roughly doubled in size while the willingness and ability of bond dealers to provide liquidity into a stressed market has fallen by more than -80%. At the same time, this market has a brand-new class of investors, who are likely to expect daily liquidity if and when market behavior turns sour. At the very least, it is clear that this is a very different corporate bond market and history-based financial models will most likely be found wanting.

The “new class” of investors he mentions are corporate bond ETF and mutual fund shareholders. These funds have exploded in size (high yield alone is now around $2 trillion) and their design presumes a market with ample liquidity.

We barely have such a market right now, and we certainly won’t have one after rates jump another 50–100 basis points.

Worse, I don’t have enough exclamation points to describe the disaster when high-yield funds, often purchased by mom-and-pop investors in a reach for yield, all try to sell at once, and the funds sell anything they can at fire-sale prices to meet redemptions.

In a bear market you sell what you can, not what you want to. We will look at what happens to high-yield funds in bear markets in a later letter. The picture is not pretty.

Leverage, Leverage, Leverage

To make matters worse, many of these lenders are far more leveraged this time. They bought their corporate bonds with borrowed money, confident that low interest rates and defaults would keep risks manageable.

In fact, according to S&P Global Market Watch, 77% of corporate bonds that are leveraged are what’s known as “covenant-lite.” That means the borrower doesn’t have to repay by conventional means.

Somehow, lenders thought it was a good idea to buy those bonds. Maybe that made sense in good times. In bad times? It can precipitate a crisis. As the economy enters recession, many companies will lose their ability to service debt, especially now that the Fed is making it more expensive to roll over—as multiple trillions of dollars will need to do in the next few years.

Normally this would be the borrowers’ problem, but covenant-lite lenders took it on themselves.

The macroeconomic effects will spread even more widely. Companies that can’t service their debt have little choice but to shrink. They will do it via layoffs, reducing inventory and investment, or selling assets.

All those reduce growth and, if widespread enough, lead to recession.

Let’s look at this data and troubling chart from Bloomberg:

Companies will need to refinance an estimated $4 trillion of bonds over the next five years, about two-thirds of all their outstanding debt, according to Wells Fargo Securities.

https://www.zerohedge.com/sites/default/files/inline-images/debt_1.png?itok=tDF0bTIX

This has investors concerned because rising rates means it will cost more to pay for unprecedented amounts of borrowing, which could push balance sheets toward a tipping point. And on top of that, many see the economy slowing down at the same time the rollovers are peaking.

“If more of your cash flow is spent into servicing your debt and not trying to grow your company, that could, over time—if enough companies are doing that—lead to economic contraction,” said Zachary Chavis, a portfolio manager at Sage Advisory Services Ltd. in Austin, Texas. “A lot of people are worried that could happen in the next two years.”

The problem is that much of the $2 trillion in bond ETF and mutual funds isn’t owned by long-term investors who hold maturity. When the herd of investors calls up to redeem, there will be no bids for their “bad” bonds.

But they’re required to pay redemptions, so they’ll have to sell their “good” bonds. Remaining investors will be stuck with an increasingly poor-quality portfolio, which will drop even faster.

Wash, rinse, repeat. Those of us with a little gray hair have seen this before, but I think the coming one is potentially biblical in proportion.

Source: ZeroHedge

Recession: When You See It, It Will Be Too Late

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Recession-Too-Late.png

“There are no signs of recession. Employment growth is strong. Jobless claims are low and the stock market is up.” 

This is heard almost daily from the media mainstream pablum.

The problem with a majority of the “analysis” done today is that it is primarily short-sighted and lazy, produced more for driving views and selling advertising rather than actually helping investors.

For example:

“The economy is currently growing at more than 2% annualized with current estimates near 2% as well.”

If you are growing at 2%, how could you have a recession anytime soon?

Let’s take a look at the data below of real economic growth rates:

  • January 1980:        1.43%
  • July 1981:                4.39%
  • July 1990:                1.73%
  • March 2001:           2.30%
  • December 2007:    1.87%

If you look at each of those dates, the economy was clearly growing. But each of those dates is the growth rate of the economy immediately prior to the onset of a recession.

You will remember that during the entirety of 2007, the majority of the media, analyst, and economic community were proclaiming continued economic growth into the foreseeable future as there was “no sign of recession.”

I myself was rather brutally chastised in December of 2007 when I wrote that:

“We are now either in, or about to be in, the worst recession since the ‘Great Depression.’”

Of course, a full year later, after the annual data revisions had been released by the Bureau of Economic Analysis (BEA), the recession was officially revealed. Unfortunately, by then it was far too late to matter.

It is here the mainstream media should have learned their lesson. But unfortunately, they didn’t.

The chart below shows the S&P 500 index with recessions and when the National Bureau of Economic Research dated the start of the recession.

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2017/12/SP500-NBER-Recession-Dating-120817.png

There are three lessons that should be learned from this:

  1. The economic “number” reported today will not be the same when it is revised in the future.
  2. The trend and deviation of the data are far more important than the number itself.
  3. “Record” highs and lows are records for a reason as they denote historical turning points in the data.

For example, the level of jobless claims is one data series currently being touted as a clear example of why there is “no recession” in sight. As shown below, there is little argument that the data currently appears extremely “bullish” for the economy.

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2017/12/Jobless-Claims-120817.png

However, if we step back to a longer picture we find that such levels of jobless claims have historically noted the peak of economic growth and warned of a pending recession.

https://i1.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Claims-4mth-MA-vs-12mth-MA-031818.png

This makes complete sense as “jobless claims” fall to low levels when companies “hoard existing labor” to meet current levels of demand. In other words, companies reach a point of efficiency where they are no longer terminating individuals to align production to aggregate demand. Therefore, jobless claims naturally fall.

But there is more to this story.

Less Than Meets The Eye

The Trump Administration has taken a LOT of credit for the recent bumps in economic growth. We have warned this was not only dangerous, credibility-wise, but also an anomaly due to three massive hurricanes and two major wildfires that had the “broken window” fallacy working overtime.

“The fallacy of the ‘broken window’ narrative is that economic activity is only changed and not increased. The dollars used to pay for the window can no longer be used for their original intended purpose.”

If economic destruction led to long-term economic prosperity, then the U.S. should just regularly drop a “nuke” on a major city and then rebuild it. When you think about it in those terms, you realize just how silly the whole notion is.

However, in the short-term, natural disasters do “pull forward” consumption as individuals need to rebuild and replace what was previously lost. This activity does lead to a short-term boost in the economic data, but fades just as quickly.

A quick look at core retail sales over the last few months, following the hurricanes, shows the temporary bump now fading.

https://i1.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/02/Retail-Sales-Core-021518.png

The other interesting aspect of this is the rise in consumer credit as a percent of disposable personal income. The chart below indexes both consumer credit to DPI and retail sales to 100 starting in 1993. What is interesting to note is the rising level of credit card debt required to sustain retail sales.

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/02/Consumer-Credit-DPI-RetailSales-Index-021518.png

Given that retail sales make up roughly 40% of personal consumption expenditures which in turn comprises roughly 70% of GDP, the impact to sustained economic growth is important to consider.

Furthermore, what the headlines miss is the growth in the population. The chart below shows retails sales divided by the current 16-and-over population. (If you are alive, you consume.) 

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Retail-Sales-Per-Capita-031818.png

Retail sales per capita were previously on a 5% annualized growth trend beginning in 1992. However, after the financial crisis, the gap below that long-term trend has yet to be filled as there is a 23.2% deficit from the long-term trend. It is also worth noting the sharp drop in retail sales per capita over just the last couple of months in particular.

Since 1992, as shown below, there have only been 5-other times in which retail sales were negative 3-months in a row (which just occurred). Each time, the subsequent impact on the economy, and the stock market, was not good. 

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Retail-Sales-Monthly-Change-031718.png

So, despite record low jobless claims, retail sales remain exceptionally weak. There are two reasons for this which are continually overlooked, or worse simply ignored, by the mainstream media and economists.

The first is that despite the “longest run of employment growth in U.S. history,” those who are finding jobs continues to grow at a substantially slower pace than the growth rate of the population.

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Employment-Population-Growth-031718.png

If you don’t have a job, and are primarily living on government support (1-of-4 Americans receive some form of benefit) it is difficult to consume at higher levels to support economic growth.

Secondly, while tax cuts may provide a temporary boost to after-tax incomes, that income boost is simply being absorbed by higher energy, gasoline, health care and borrowing costs. This is why 80% of Americans continue to live paycheck-to-paycheck and have little saved in the bank. It is also why, as wages have continued to stagnate, the cost of living now exceeds what incomes and debt increases can sustain.

https://i0.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/02/Gap-Income-Spending-Saving-022718.png

As I have discussed several times during the 4th-quarter of 2017:

Very likely, the next two quarters will be weaker than expected as the boost from hurricanes fade and higher interest rates take their toll on consumers. So, when mainstream media acts astonished that economic growth has once again slowed, you will already know why.”

Not surprisingly the economic data rolling in has been exceptionally weak and the first quarter GDP growth is now targeted at less than 2% annualized growth.

https://i2.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/GDP-NOW.png

However, it is not only in the U.S. the economic “bump” is fading, but globally as well as Central Banks have started to remove their monetary accommodations. As noted by the ECRI:

“Our prediction last year of a global growth downturn was based on our 20-Country Long Leading Index, which, in 2016, foresaw the synchronized global growth upturn that the consensus only started to recognize around the spring of 2017.

With the synchronized global growth upturn in the rear view mirror, the downturn is no longer a forecast, but is now a fact.

The chart below shows that quarter-over-quarter annualized gross domestic product growth rates in the three largest advanced economies — the U.S., the euro zone, and Japan — have turned down. In all three, GDP growth peaked in the second or third quarter of 2017, and fell in the fourth quarter. This is what the start of a synchronized global growth downswing looks like.”

https://i1.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/GDP-Global-031818.gif

“Still, the groupthink on the synchronized global growth upturn is so pervasive that nobody seemed to notice that South Korea’s GDP contracted in the fourth quarter of 2017, partly due to the biggest drop in its exports in 33 years. And that news came as the country was in the spotlight as host of the winter Olympics.

Because it’s so export-dependent, South Korea is often a canary in the coal mine of global growth. So, when the Asian nation experiences slower growth — let alone negative growth — it’s a yellow flag for the global economy.

The international slowdown is becoming increasingly obvious from the widely followed economic indicators. The most popular U.S. measures seem to present more of a mixed bag. Yet, as we pointed out late last year, the bond market, following the U.S. Short Leading Index, started sniffing out the U.S. slowdown months ago.”

You can see the slowdown occurring “real time” by taking a look at Personal Consumption Expenditures (PCE) which comprises roughly 70% of U.S. economic growth. (It is also worth noting that PCE  growth rates have been declining since 2016 which belies the “economic growth recovery” story.)

https://i0.wp.com/realinvestmentadvice.com/wp-content/uploads/2018/03/Real-Retail-Sales-PCE-031818.png

The point here is this:

“Economic cycles are only sustainable for as long as excesses are being built. The natural law of reversions, while they can be suspended by artificial interventions, cannot be repealed.” 

While there may currently be “no sign of recession,” there are plenty of signs of “economic stress” such as:

The shift caused by the financial crisis, aging demographics, massive monetary interventions and the structural change in employment which has skewed the seasonal-adjustments in economic data. This makes every report from employment, retail sales, and manufacturing appear more robust than they would be otherwise. This is a problem mainstream analysis continues to overlook but will be used as an excuse when it reverses.

While the calls of a “recession” may seem far-fetched based on today’s economic data points, no one was calling for a recession in early 2000 or 2007 either. By the time the data is adjusted, and the eventual recession is revealed, it won’t matter as the damage will have already been done.

As Howard Marks once quipped:

“Being right, but early in the call, is the same as being wrong.” 

While being optimistic about the economy and the markets currently is far more entertaining than doom and gloom, it is the honest assessment of the data, along with the underlying trends, which are useful in protecting one’s wealth longer-term.

Is there a recession currently? No.

Will there be a recession in the not so distant future? Absolutely.

But if you wait to “see it,” it will be too late to do anything about it.

Whether it is a mild, or “massive,” recession will make little difference to individuals as the net destruction of personal wealth will be just as damaging. Such is the nature of recessions on the financial markets.

By Lance Roberts | Real Investment Advice

Fed Hints During Next Recession It Will Release Targeted ‘Universal Income’ and NIRP

In a moment of rare insight, two weeks ago in response to a question “Why is establishment media romanticizing communism? Authoritarianism, poverty, starvation, secret police, murder, mass incarceration? WTF?”, we said that this was simply a “prelude to central bank funded universal income”, or in other words, Fed-funded and guaranteed cash for everyone.

On Thursday afternoon, in a stark warning of what’s to come, San Francisco Fed President John Williams confirmed our suspicions when he said that to fight the next recession, global central bankers will be forced to come up with a whole new toolkit of “solutions”, as simply cutting interest rates won’t well, cut it anymore, and in addition to more QE and forward guidance – both of which were used widely in the last recession – the Fed may have to use negative interest rates, as well as untried tools including so-called price-level targeting or nominal-income targeting.

This is a bold, tactical admission that as a result of the aging workforce and the dramatic slack which still remains in the labor force that the US central bank will have to take drastic steps to preserve social order and cohesion.

According to Williams’, Reuters reports, central bankers should take this moment of “relative economic calm” to rethink their approach to monetary policy. Others have echoed Williams’ implicit admission that as a result of 9 years of Fed attempts to stimulate the economy – yet merely ending up with the biggest asset bubble in history – the US finds itself in a dead economic end, such as Chicago Fed Bank President Charles Evans, who recently urged a strategy review at the Fed, but Williams’ call for a worldwide review is considerably more ambitious.

Among Williams’ other suggestions include not only negative interest rates but also raising the inflation target – to 3%, 4% or more, in an attempt to crush debt by making life unbearable for the majority of the population – as it considers new monetary policy frameworks. Still, even the most dovish Fed lunatic has to admit that such strategies would have costs, including those that diverge greatly from the Fed’s current approach. Or maybe not: “price-level targeting, he said, is advantageous because it fits “relatively easily” into the current framework.”

Considering that for the better part of a decade the Fed prescribed lower rates and ZIRP as the cure to the moribund US economy, only to flip and then propose higher rates as the solution to all problems. It is not surprising that even the most insane proposals are currently being contemplated because they fit “relatively easily” into the current framework.

Additionally, confirming that the Fed has learned nothing at all, during a Q&A in San Francisco, Williams said that “negative interest rates need to be on the list” of potential tools the Fed could use in a severe recession. He also said that QE remains more effective in terms of cost-benefit, but “would not exclude that as an option if the circumstances warranted it.”

“If all of us get stuck at the lower bound” then “policy spillovers are far more negative,” Williams said of global economic interconnectedness. “I’m not pushing for” some “United Nations of policy.”

And, touching on our post from mid-September, in which we pointed out that the BOC was preparing to revising its mandate, Williams also said that “the Fed and all central banks should have Canada-like practice of revisiting inflation target every 5 years.”

Meanwhile, the idea of Fed targeting, or funding, “income” is hardly new: back in July, Deutsche Bank was the first institution to admit that the Fed has created “universal basic income for the rich”:

The accommodation and QE have acted as a free insurance policy for the owners of risk, which, given the demographics of stock market participation, in effect has functioned as universal basic income for the rich. It is not difficult to see how disruptive unwind of stimulus could become. Clearly, in this context risk has become a binding constraint.

It is only “symmetric” that everyone else should also benefit from the Fed’s monetary generosity during the next recession. 

* * *

Finally, for those curious what will really happen after the next “great liquidity crisis”, JPM’s Marko Kolanovic laid out a comprehensive checklist one month ago. It predicted not only price targeting (i.e., stocks), but also negative income taxes, progressive corporate taxes, new taxes on tech companies, and, of course, hyperinflation. Here is the excerpt.

What will governments and central banks do in the scenario of a great liquidity crisis? If the standard rate cutting and bond purchases don’t suffice, central banks may more explicitly target asset prices (e.g., equities). This may be controversial in light of the potential impact of central bank actions in driving inequality between asset owners and labor. Other ‘out of the box’ solutions could include a negative income tax (one can call this ‘QE for labor’), progressive corporate tax, universal income and others. To address growing pressure on labor from AI, new taxes or settlements may be levied on Technology companies (for instance, they may be required to pick up the social tab for labor destruction brought by artificial intelligence, in an analogy to industrial companies addressing environmental impacts). While we think unlikely, a tail risk could be a backlash against central banks that prompts significant changes in the monetary system. In many possible outcomes, inflation is likely to pick up.

The next crisis is also likely to result in social tensions similar to those witnessed 50 years ago in 1968. In 1968, TV and investigative journalism provided a generation of baby boomers access to unfiltered information on social developments such as Vietnam and other proxy wars, Civil rights movements, income inequality, etc. Similar to 1968, the internet today (social media, leaked documents, etc.) provides millennials with unrestricted access to information on a surprisingly similar range of issues. In addition to information, the internet provides a platform for various social groups to become more self-aware, united and organized. Groups span various social dimensions based on differences in income/wealth, race, generation, political party affiliations, and independent stripes ranging from alt-left to alt-right movements. In fact, many recent developments such as the US presidential election, Brexit, independence movements in Europe, etc., already illustrate social tensions that are likely to be amplified in the next financial crisis. How did markets evolve in the aftermath of 1968? Monetary systems were completely revamped (Bretton Woods), inflation rapidly increased, and equities produced zero returns for a decade. The decade ended with a famously wrong Businessweek article ‘the death of equities’ in 1979.

Kolanovic’s warning may have sounded whimsical one month ago. Now, in light of Williams’ words, it appears that it may serve as a blueprint for what comes next.

Source: ZeroHedge

Yields Acting Like Economy Is Heading Into Recession

Treasury Yields and Rate Hike Odds Sink: Investigating the Yield Curve

The futures market is starting to question the June rate hike thesis. For its part, the bond market is behaving as if the Fed is hiking the economy into a recession. Here are some pictures.

June Rate Hike Odds

https://mishgea.files.wordpress.com/2017/05/fedwatch-2017-05-17.png?w=768&h=693

No Hike in June Odds

  • Month ago – 51%
  • Week Ago – 12.3%
  • Yesterday – 21.5%
  • Today – 35.4%

10-Year Treasury Note Yield

https://mishgea.files.wordpress.com/2017/05/10-year-2017-05-171.png?w=625

The yield on the 10-year treasury note doubled from the low of 1.32% during the week of July 2, 2016, to the high 2.64% during the week of December 10, 2016.

Since March 11, 2017, the yield on the 10-year treasury note declined 40 basis points to 2.24%.

30-Year Long Bond

https://mishgea.files.wordpress.com/2017/05/30-year-2017-05-17.png?w=625

The yield on the 30-year treasury bond rose from the low of 2.09% during the week of July 2, 2016, to the high of 3.21% during the week of March 11, 2017.

Since March 11, 2017, the yield on the 30-year treasury bond declined 29 basis points to 2.92%

1-Year Treasury Note Yield

https://mishgea.files.wordpress.com/2017/05/1-year-2017-05-17.png?w=625

The yield on the 1-year treasury more than doubled from the low of 0.43% during the week of July 2, 2016, to the high 1.14% during the week of May 6, 2017.

Since March 11, 2017, the yield curve has flattened considerably.

Action in the treasury yields is just what one would expect if the economy was headed into recession.

By Mike “Mish” Shedlock | MishTalk

A Near Certainty On The Next President’s Watch ● — ● Recession!

Talk about a poisoned chalice. No matter who is elected to the White House in November, the next president will probably face a recession.

The 83-month-old expansion is already the fourth-longest in more than 150 years and starting to show some signs of aging as corporate profits peak and wage pressures build. It also remains vulnerable to a shock because growth has been so feeble, averaging just about 2 percent since the last downturn ended in June 2009.

“If the next president is not going to have a recession, it will be a U.S. record,” said Gad Levanon, chief economist for North America at the Conference Board in New York. “The longest expansion we ever had was 10 years,” beginning in 1991.

-1x-1The history of cyclical fluctuations suggests that the “odds are significantly better than 50-50 that we will have a recession within the next three years,” according to former Treasury Secretary Lawrence Summers.

Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. in New York, puts the probability of a downturn during that time frame at about two in three.

The U.S. doesn’t look all that well-equipped to handle a contraction should one occur during the next president’s term, former Federal Reserve Vice Chairman Alan Blinder said. Monetary policy is stretched near its limit while fiscal policy is hamstrung by ideological battles.

Previous Decade

This wouldn’t be the first time that a new president was forced to tackle a contraction in gross domestic product. The nation was in the midst of its deepest slump since the Great Depression when Barack Obama took office on January 20, 2009. His predecessor, George W. Bush, started his tenure as president in 2001 with the economy about to be mired in a downturn as well, albeit a much milder one than greeted Obama.

The biggest near-term threat comes from abroad. Former International Monetary Fund official Desmond Lachman said a June 23 vote by the U.K. to leave the European Union, a steeper-than-anticipated Chinese slowdown and a renewed recession in Japan are among potential developments that could upend financial markets and the global economy in the coming months.

“There’s a non-negligible risk that by the time the next president takes office in January you would have the world in a pretty bad place,” said Lachman, who put the odds of that happening at 30 percent to 40 percent.

Investors also might get spooked if billionaire Donald Trump looks likely to win the presidency, considering his staunchly protectionist stance on trade and a seemingly cavalier attitude toward the nation’s debt, added Lachman, now a resident fellow at the American Enterprise Institute in Washington.

Election-Year Jitters

Uncertainty about the election’s outcome may already be infecting the economy at the margin, with companies and consumers in surveys increasingly citing it as a source of concern.

“The views expressed by the various candidates have weighed down” consumer confidence, said Richard Curtin, director of the University of Michigan’s household survey, which saw sentiment slip for a fourth straight month in April.

-1x-1 (1)With growth so slow — it clocked in at a mere 0.5 percent on an annual basis in the first quarter — it wouldn’t take that much to tip the economy into a recession.

“It’s like a bicycle that’s going too slowly. All it takes is a little puff of wind to knock it over,” said Nariman Behravesh, chief economist for consultants IHS Inc. in Lexington, Massachusetts.

The economy still has some things going for it, leading Behravesh to conclude that the odds of a downturn over the next couple of years are at most 25 percent.

“Recoveries don’t die of old age,” he said. “They get killed off. And the three killers that we’ve had in the past don’t seem terribly frightening right now.”

The murderers’ row consists of a steep rise in interest rates engineered by the central bank, a sudden spike in oil prices and the bursting of an asset-price bubble. This time around, Fed policy makers have signaled they’re going to raise rates slowly, the oil market is still awash in excess supply and house prices by some measures remain below their 2007 highs.

“The expansion can continue for several more years,” Robert Gordon, a professor at Northwestern University in Evanston, Illinois, and a member of the committee of economists that determines the timing of recessions, said in an e-mail.

Balance Sheets

Consumers’ balance sheets are in much better shape than they were prior to the last economic contraction. Household debt as a share of disposable income stood at 105 percent in the fourth quarter, well below the 133 percent reached in the final three months of 2007.

Businesses seem more vulnerable. Corporate profits plunged 11.5 percent in the fourth quarter from the year-ago period, the biggest drop since a 31 percent collapse at the end of 2008 during the height of the financial crisis, according to data compiled by the Commerce Department.

History shows that when earnings decline, the economy often follows into a recession as profit-starved companies cut back on hiring and investment.

-1x-1 (2)“More and more employers are struggling with profits,” Levanon said. “That is resulting in some belt tightening.”

While he doesn’t see that pushing the U.S. into a recession, Levanon expects monthly payroll growth to slow to 150,000 to 180,000 over the balance of this year, compared to an average of 229,000 in 2015.

Though much of the weakness in earnings has been concentrated in the energy industry, companies in general have been struggling with rising labor costs as the tightening jobs market puts upward pressure on wages and worker productivity has lagged.

Peter Hooper, chief economist for Deutsche Bank Securities in New York, sees that leading to a possible recession a couple of years out as companies raise prices, inflation starts to accelerate and Fed policy makers have to jack up interest rates more aggressively in response.

“The slower they go in the near-term, the bigger the risk down the road,” he said of the Fed. “Looking out over the next four years, the chances of a two-quarter contraction are probably above 50 percent.”

Source: David Stockman’s Contra Corner | Rich Miller, Bloomberg

Welcome To The Revenue Recession

 

The “Revenue Recession” is alive and well, at least when it comes to the 30 companies of the Dow Jones Industrial Average. 

Every month we look at what brokerage analysts have in their financial models in terms of expected sales growth for the Dow constituents.  This year hasn’t been pretty, with Q1 down an average of 0.8% from last year and Q2 to be down 3.5% (WMT and HD still need to report to finish out the quarter).  The hits keep coming in Q3, down an expected 4.0% (1.4% less energy) and Q4 down 1.8% (flat less energy). 

The good news is that if markets discount 2 quarters ahead, we should be through the rough patch because Q1 2015 analyst numbers call for 1.9% sales growth, with or without the energy names of the Dow. The bad news is that analysts tend to be too optimistic: back in Q3 last year they thought Q2 2015 would be +2%, and that didn’t work out too well. 

Overall, the lack of revenue growth combined with full equity valuations (unless you think +17x is cheap) is all you need to know about the current market churn. And why it will likely continue.

The most successful guy I’ve ever worked for – and he has the billions to prove it – had the simplest mantra: “Don’t make things harder than they have to be”.  In the spirit of that sentiment, consider a simple question: which Dow stocks have done the best and worst this year, and why?  Here’s the answer:

The three best performing names are UnitedHealth (+19.3%), Visa (+18.2%) and Disney (14.2%).

The worst three names are Dupont (-28.3%), Chevron (-23.5%) and Wal-Mart (-16.0%).

Now, consider the old market aphorism that “Markets discount two quarters ahead” (remember, we’re keeping this simple).   What are analysts expecting for revenue growth in Q3 and Q4 that might have encouraged investors to reprice these stocks higher in the first 7 months of the year?


For the three best performing stocks, analysts expect second half revenues to climb an average of 14.1% versus last year. 

And for the worst three?  How about -22.1%. Don’t make things harder than they have to be.

That, in a nutshell, is why we look at the expected revenue growth for the 30 companies of the Dow every month.  Even though earnings and interest rates ultimately drive asset prices, revenues are the headwaters of the cash flow stream.  They also have the benefit of being easier for an analyst to quality control than earnings.  Not easy, mind you – just easier.  Units, price and mix are the only three drivers of revenues you have to worry about.  When those increase profitably the rest of the income statement – including the bottom line – tends to take care of itself.  

By both performance and revenue growth measures, 2015 has been tough on the Dow. It is the only one of the three major U.S. “Indexes” to be down on the year, with a 2.3% decline versus  +1.2% for the S&P 500 and +6.3% for the NASDAQ.  Ten names out of the 30 are lower by 10% or more, or a full 33%.  By comparison, we count 107 stocks in the S&P 500 that are lower by 10% or greater, or only 21% of that index.  

Looking at the average revenue growth for the Dow names tells a large part of the story, for the last time the Average enjoyed positive top line momentum was Q3 2014 and the next time brokerage analysts expect actual growth isn’t until Q1 2016. The two largest problems are well understood: declining oil and other commodity prices along with an increase in the value of the dollar. For a brief period there was some hope that declining energy company revenues would migrate to other companies’ top lines as consumers spent their energy savings elsewhere.  That, of course, didn’t quite work out.  

Still, we are at the crosswords of what could be a turn back to positive growth in 2016. Here’s how Street analysts currently expect that to play out:

At the moment, Wall Street analysts that cover the companies of the Dow expect Q3 2015 to be the trough quarter for revenue growth for the year.  On average, they expect the typical Dow name to print a 4.0% decline in revenues versus last year.  Exclude financials, and the comp gets a little worse: 4.4%.  Take out the 2 energy names, and the expected comp is still negative to the tune of 1.5%.

Things get a little better in Q4, presumably because we start to anniversary the declines in oil prices as well as the strength of the dollar.  These both began to kick in during Q4 2014, and as the old Wall Street adage goes “Don’t sweat a bad quarter – it just makes next year’s comp that much easier”.  That’s why analysts are looking for an average of -1.8% revenue comps for Q4, and essentially flat (-0.01%) when you take out the Dow’s energy names.

Go all the way out to Q1 2016, and analysts expect revenue growth to finally turn positive: 1.9% versus Q1 2015, whether you’re talking about the whole Average or excluding the energy names Better still, analysts are showing expected revenue growth for all of 2016 at 4.1%.  OK, that’s probably overly optimistic unless the dollar weakens next year.  But after 2015, even 1-3% growth would be welcome.

We’re still keeping it simple, so let’s wrap up.  What ails the Dow names also hamstrings the U.S. equity market as whole.  We need better revenue growth than the negative comps we’ve talked about here or the flattish top line progressions of the S&P 500 to get stocks moving again. The third quarter seems unlikely to provide much relief.  On a more optimistic note, our chances improve in Q4 and even more so in Q1 2016. Until we see the U.S. economy accelerate and/or the dollar weaken and/or oil prices stabilize, the chance that investors will pay even higher multiples for stagnant earnings appears remote.  That’s a recipe for more volatility – potentially a lot more.

Via Zero Hedge … Via ConvergEx’s Nick Colas