This post is an amalgam of various emails I penned over the course of July, August and September trying to provide hard evidence to support my belief that we are slipping into another recession in Q4 or Q1 2012 which unfortunately, will most likely be global in nature.
This is clearly not currently the consensus on The Street, although we have seen over the last quarter that global growth forecasts have been lowered and people are at least considering the possibility that it might happen. I’d like to contrast this with the beginning of 2011 when outlooks were MUCH rosier and people GENUINELY, in their heart of hearts, thought that we’d see rate interest rises in the developed world up to maybe 2%.
Many Sell-Side analysts are currently telling us that a recession is now already fully discounted in stock prices – I respectfully disagree. These are the same sell-side analysts who didn’t see even a remote recession risk just 6 months ago and the same guys who didn’t see a recession coming down the tracks in 2007 either.
Most value investors don’t pay much attention to the macro situation but I think they are missing a trick. Given that the average stock market decline during a recession is 40% it seems to me that an attempt to be “macro aware” is worth the effort!
The Purpose of this Post is to encourage caution! Although much of what I post on this blog will be long equity ideas I do think that I should emphasise that I am not bullish on the broad indexes, infact I err bearishly! I usually hedge my longs with at least some degree of shorts on various indexes of my choice. These are not valuation levels at which I want to be naked long and the political/economic/monetary picture is so cloudy that I fear we must practice defensive investing. More Cash, Lower Net Exposure.
I don’t particularly like this from M&G and David Rosenberg. I don’t like that it relies upon only ONE variable, but it works.
As you can see the blue line tends to lead the orange line, effectively the business “outlook” leads the actual output of the economy which makes intuitive sense. Businesses become more pessimistic and then reign in spending which has knock on effects throughout the supply chain. Only the instance in 2001 acts as an exception – when the economy didn’t quite slump along with business confidence.
This more complete analysis is lifted from the supremely insightful and diligent John Hussman – he has compiled what he calls a “Recession Warning Composite”….
“The components of our recession warning composite might be called “weak learners” in that none of them, individually, has a particularly notable record in anticipating recessions. The full syndrome of conditions, however, captures a critical “signature” of recessions. That signature of “early warning” conditions is based on financial market indicators including credit spreads, equity prices and yield curve behavior, coupled with slowing in measures of employment and business activity. Every historical instance of this full syndrome has been associated with an ongoing or immediately impending recession.”
The components are:
1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields.
2: Falling stock prices: S&P 500 below its level of 6 months earlier.
3: Weak ISM Purchasing Managers Index: PMI below 50, or
3: (alternate): Moderating ISM and employment growth: PMI below 54, coupled with slowing employment growth: either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron’s piece many years ago), or an unemployment rate up 0.4% or more from its 12-month low.
4: Moderate or flat yield curve: 10-year Treasury yield no more than 2.5% above 3-month Treasury yields if condition 3 is in effect, or any difference of less than 3.1%
Components 1, 2 and 4 are all obviously flashing RED for danger and we posted an August PMI of 50.6 for the US Economy! In addition, we have an unemployment rate that is starting to creep up again from already elevated levels. So as far as I’m concerned Criteria 3 has been met too. What that means is that EITHER this composite will be proven wrong and its 100% track record is ruined or we will enter another recession. Given the tepid nature of the data, the mess in Europe and the negative growth surprises in Asia, I fail to see where the US economy pulls the proverbial rabbit from.
Look at the video below with Lakshman Achuthan of the Economic Cycle Research Institute. As he points out he has no record of being wrong on this, his recession call track record is perfect. This video is a must watch.
“A broad range – this is not based on any one indicator – this is based on dozens of indicators for the United States – there is a contagion among those forward looking indicators that we only see at the onset of a business cycle recession.