Is the U.S. economy about to experience a major downturn? Unfortunately, there are a whole bunch of signs that economic activity in the United States is really slowing down right now. Freight volumes and freight expenditures are way down, consumer confidence has declined sharply, major retail chains all over America are closing hundreds of stores, and the “sequester” threatens to give the American people their first significant opportunity to experience what “austerity” tastes like. Gas prices are going up rapidly, corporate insiders are dumping massive amounts of stock and there are high profile corporate bankruptcies in the news almost every single day now. In many ways, what we are going through right now feels very similar to 2008 before the crash happened. Back then the warning signs of economic trouble were very obvious, but our politicians and the mainstream media insisted that everything was just fine, and the stock market was very much detached from reality. When the stock market did finally catch up with reality, it happened very, very rapidly. Sadly, most people do not appear to have learned any lessons from the crisis of 2008. Americans continue to rack up staggering amounts of debt, and Wall Street is more reckless than ever. As a society, we seem to have concluded that 2008 was just a temporary malfunction rather than an indication that our entire system was fundamentally flawed. In the end, we will pay a great price for our overconfidence and our recklessness. (Read More….)
We first noticed the first signs that the economy was beginning to soften about three months ago. Now the evidence of a slowdown has become so overwhelming that it is difficult to avoid the conclusion that we are headed for a recession. We cite the following as evidence.
Retail sales (both total and non-auto) have dropped for three consecutive months. This has happened only five times since 1967—-four times in 2008, and one now. Vehicle sales have tapered off with May and June being the two weakest months of the year. Consumer confidence for both the Conference Board index and the University of Michigan Survey are at their lowest levels of 2012.
On the labor front, June payroll numbers were weak once again and averaged only 75,000 in the second quarter. The latest weekly new claims for unemployment insurance jumped back up to 386,000 and the last two months have been well above the numbers seen earlier in the year.
The ISM manufacturing index for June fell 3.8 points to 49.7, its first sub-50 reading in the economic recovery. The ISM non-manufacturing index for June dropped to its lowest level since January 2010. Most recently the Philadelphia Fed Survey for July was negative (below zero) for the third consecutive month.
The small business confidence index declined in June to its lowest level since October and has now dropped in three of the last four months. Plans for capital spending and new hiring have dropped sharply.
Despite all of the talk about a housing bottom, June existing home sales fell 5.4% to its lowest level since the fall of last year. In addition mortgage applications for home purchases have been range-bound since October.
Core factory orders, while volatile on a month-to-month basis, have declined 2.6% since year-end, and the ISM numbers cited above indicate the weakness is likely to continue.
The Conference Board Index of leading indicators has declined for two of the last three months and is now up only 1.4% over a year earlier, the lowest since November of 2009, when it was climbing from recessionary numbers. The ECRI Weekly Leading Index is indicating a recession is either here now or will begin in the next few months.
The breadth and depth of the slowdown are greater than the growth pauses experienced in mid-2010 and mid-2011, and indicate a strong likelihood of recession ahead. In addition the foreign economies will be a drag as well. A number of European nations are already in recession and others are on the cusp. The debt, deficit and balance sheet problems of the EU’s southern tier are a long way from any solution, and will not remain out of the news for long. China is coming down from a major real estate and credit boom, and is not likely to avoid a hard landing. The Shanghai Composite is in a major downtrend, declining 28% since April 2011. The view that China is immune because of their unique economic system reminds us of what people were saying about Japan in 1989.
The stock market is ignoring these fundamentals as it did in early 2000 and late 2007 in the belief that the Fed can pull another rabbit out its hat. It couldn’t do it in 2000 or 2007 when it had plenty of weapons at its disposal. Now there is little that the Fed can do, although it will try since it will not get any help, as Senator Schumer so aptly pointed out at Bernanke’s Senate testimony. In sum, we believe that the stock market is in store for a huge disappointment.
- Index of U.S. Leading Indicators Falls More Than Forecast – Bloomberg (bloomberg.com)
- Economic data add to signs of slowing recovery (rep-am.com)
- 12 Signs That The Next Recession In The United States Has Already Begun (judgementofamerica.wordpress.com)
- This is what a recession really is (business.financialpost.com)
- 12 Signs Showing The Next Recession In The U.S. Is Underway (GLD, TZA, FAZ, FAS, INDEXSP:.INX) (etfdailynews.com)
- Recession Now More Likely (blogs.wsj.com)
- 12 Signs That The Next Recession In The United States Has Already Begun (investmentwatchblog.com)
In Part 1 of this series, Is This The Best Stock Market Indicator Ever?, I examined the technical indicator known as $OEXA200R, that is, the percentage of S&P 100 stocks above their 200 day moving average, found on StockCharts.com.
The $OEXA200R can be thought of as a valuable early yellow light flashing ‘bears ahead’ or a confirmatory green light that we’re really back in a bull market after a bear. It is an extremely accurate market timing and short term predictive tool for any investor.
But what of the long term trends in the market? What does the future hold over the next 2 or 5 or 20 years? Is there a predictive tool for that?
I believe there is.
In this article we will analyze the long term S&P chart developed by Doug Short (Figure 1), using it as a reference to “tease out” some very specific predictions of future trends. The estimates and scenarios are based on an unbiased interpretation of data derived from this chart.
By following the cold data where it leads us, we arrive at some unnerving predictions which I will collectively refer to as The Great Repression.
Figure 1 illustrates the long term trend of the S&P from 1870 to present. It is inflation-adjusted and set on a log scale for clarity. Notice the red trend line and how the market regresses from bull and bear periods back to the historical trend.
Below the S&P graphic on Figure 1 is an illustration of S&P variance from trend. That is, the percentage the S&P skewed above or below the trend line at corresponding time points. For example, at the 1929 bull peak the S&P was at 82% variance above the trend line. In 1982, the S&P had fallen to minus 55% variance below the trend line.”
An analysis of the chart (Figure 2) revels that the slopes from each bull top measured at the highest variance points in 1901, 1929 and 1965 to the beginning of the next bulls in 1920, 1949 and 1982 all measure exactly 34 degrees. Again, the start and end points for the slopes are determined by the variance tops indicated on the “Variance from trend” graphic, not the actual S&P tops.
Assuming the slopes could theoretically measure anywhere from 1 to 44 degrees (excluding the 45 degree vertical and 0 degree horizontal orientations), the probability of all three equaling 34 degrees is less than 1 in 79,000.
Based on that data, one could make a reasonable statistical assumption that the slope for the current secular bear market beginning in 2000 would also follow the same 34 degree angle as the previous three bears. Overlaying that slope on the 2000 bull top would suggest that we are not yet half way through the present bear cycle.
But how much more “bear”is left?
To answer that question, we add an additional green line to the S&P chart corresponding to -50% variance from the trend (Figure 3). All three bears in 1920, 1949 and 1982 have touched that line before rebounding. In fact, all three have actually exceeded -50%: 1920 at -59%, 1949 at -57%, 1982 at -55%.
If we follow the 34 degree bear slope line to the -50% green variance line, we arrive at a very conservative end point for the current bear in 2022 – 2023 with the S&P at approximately 540. That, I wish to emphasize, is the conservative scenario.
A more mathematically realistic scenario is illustrated in Figure 4. Here, a blue variance line has been added at the -65% level, below the green -50% line. This would take the end of the secular bear out to 2025 – 2026 at S&P 450.
Why is that the more likely scenario? If one looks at the variance from trend graphic, we observe extreme positive variances in 1901 (84%) and 1929 (82%) followed by dramatic corresponding negative variances in 1920 (-59%) and 1932 (-67%). The relatively moderate 1965 peak (57%) was followed by a moderate 1982 dip (-55%).
Unfortunately, in this case there is no precise correlation as there was for the 34 degree bear slopes. However, the rule seems to be that the more extreme variance goes in one direction, the more extreme it corrects in the other.
In 2000, we had variance of an unprecedented 155% above trend. There is no way to forecast how deeply the upcoming negative correction will be other than to assume it will probably be severe, that -65% is a realistic estimate and that it could very possibly drop even lower.
This would result in a situation where by 2025 the S&P at 450 has lost 65% of its December 2011 value. The market downturn would be worse than the 2008 – 2009 correction, with the current recession growing more severe but not as catastrophic as the deflationary Great Depression of the 1930’s. In other words, a “Great Repression.”
Why wouldn’t there be a repeat of the Great Depression? One can only assume that Mr. Bernanke (a student of that event) or his successor would run the Treasury printing presses until they spewed smoke and flame in order to prevent another major deflationary event. What of the near term?
Upon close examination of the chart, one can see that during the past three secular bears there was always a small dip below the S&P trend line immediately preceding a sharp decline. Figures 5 through 7 illustrate when this occurred in 1915, 1930 and 1972.
Following these downward ‘blips’ there was brief rise in the market followed by a precipitous drop. I believe this phenomenon was repeated by the 2008 – 2009 drop (‘blip’) and 2009 – 2011 cyclical bull (Figure 8).
Note another striking coincidence: in each case, the S&P fell precipitously to the -40% variance level (blue line in Figure 9 above green line). If this trend repeats a fourth time, the S&P will experience another decline in 2012 – 2013 to 580, a 54% decline in its current value.
The S&P would then likely rebound to straddle the 34 degree slope line to the end of the secular bear in 2022 – 2025, as previously discussed.
The charts point to various long and short term scenarios for the market, several of which have a very high probability of coming to pass. Statistically, it is extremely unlikely that the mathematical patterns discussed here are simply due to random chance.
Taken as a group it would seem to be virtually impossible. Although the patterns are mathematically driven and not dependent upon world events it is fascinating how current events seem to be aligning with the near term pattern. In particular, the S&P decline indicated for 2012 – 2013 coinciding with the very likely disintegration of the Eurozone and euro.
Is there a silver lining for investors somewhere within this dark cloud? I believe there is, an extremely lucrative one that will make itself apparent in 2012 as the market tumbles.
It will be examined at that time in part 3 of this series.
- CHARTS: Is This The Best Stock Market Indicator Ever? (businessinsider.com)
- The Bull, Bear, And Secular Case From BofAML (zerohedge.com)
- 4 Reasons to be Bearish (zerohedge.com)
- Converging On The Horizon (ritholtz.com)
- How to Get Started in Chart Reading (forbes.com)