Guest Post: When Will Reality Intrude?

Tyler Durden's picture

Submitted by Peak Prosperity contributor Charles Hugh Smith 

If we pursue the line of inquiry established by Chris Martenson’s recent call to Buckle Up -- Market Breakdown in Progress, we come to these basic questions: When will the market reflect the fundamental weakness of the global economy? And when will the market finally hit bottom?

First, we have to stipulate that the correlation between the real economy and the stock market is tenuous at times. According to the National Bureau of Economic Research (NBER), the widely recognized designator of recessions, the most recent recession began in December 2007 and ended in June 2009. Fully six months into the downturn (June 2008), the S&P 500 stock market index was still resiliently hovering around 1,400. The market did not break down until September 2009, the tenth month of recession. 

A mere three months after the market bottomed in March 2009, the recession ended (as determined by the NBER).

Clearly, the correlation between market action and the underlying economy is weak.  While many would declare the stock market to be a “lagging indicator” of recession, even that may be overstating the connection. If we have learned anything in the past three years, it’s that weakening the dollar to foster the illusion of rising corporate profits, central bank monetary easing (QE), and central state borrow-and-spend stimulus can goose the market higher even as the underlying economy remains weak or recessionary.

Properly inflated with cheap liquidity, the stock market could continue rising even as the real economy (as measured not just by profits but by employment, household earnings, and tax revenues) sags into recession.

Indeed, some have argued that the emergence from recession in June 2009 was largely illusory, the consequence of counting debt-funded spending as part of GDP. (By this thinking, all we need to do to avoid recession is borrow and spend $10 trillion a year forever. That this course is artificial and unsustainable doesn’t enter into the calculations.)

If recessions were defined by real household incomes (i.e., adjusted for increases in the consumer price index), then the real economy is clearly still recessionary: household incomes slipped 3.2% in the December 2007 - June 2009 recession, and then fell another 6.7% in the two years from June 2009 to June 2011. This drop in inflation-adjusted income is almost 10% (9.8%), a staggering decline in a supposed “recovery.”

The point here is that the real economy could slip further downhill while monetary/fiscal “juice” keeps the stock market buoyant.

Another line of thought suggests that Global Corporate America has effectively decoupled from the American economy. Corporate profits could continue rising, powering the stock market higher, even as most of America stumbles along in declining-income recession.

The conventional thinking, however, is that eventually the stock market will have to reflect economic reality, both domestically and globally, regardless of how much juice the Fed injects into the market.

That possibility becomes intriguing when we consider the Economic Cycle Research Institute’s (ECRI) call on September 30, 2011 that the U.S. was entering another recession. The ECRI reiterated their position in March of 2012. The ECRI argues that the U.S. is entering an era of more frequent recessions as a result of 1) declining trend of economic growth and 2) increased cyclical volatility.

Though the mainstream financial media has treated the ECRI call as an outlier, this following chart (courtesy of frequent contributor B.C.) suggests that the call may well be as prescient as ECRI asserts:


This chart displays the current post-recession Weekly Leading Index (WLI) -- the ECRI’s proprietary measure of economic activity -- with seven other postwar recessions, all plotted from the start of each recession. This enables us to examine the history of each recession from an “apples to apples” time perspective.

While each recession occurs in a unique set of circumstances, it is nonetheless striking that the current recession (WLI 2010, in solid red) tracks the sharp 1973-75 downturn, the 2001-02 “soft patch” and the 2007-09 recession rather closely in time if not in amplitude.

If history offers scenarios rather than predictions, it is interesting to note that if the current downturn follows the timeline of the relatively modest 2001-02 recession, the ultimate bottom lies out another 15 weeks.

If the present weakness tracks 1973-75, the bottom might be roughly 30 weeks ahead, while the 2007-09 recession offers a pattern that suggests the final low in the WLI might be reached about 20 weeks out.

The next chart displays the annual change in the WLI over several recessions. Since the present so evidently tracks the three recessions noted above, these downturns are the ones displayed:


Once again, we see that the final troughs in previous recessions are still ahead by between 10 and 30 weeks.

The ECRI famously reports that they have never missed identifying a recession nor made a false positive (i.e. called 10 of the last five recessions). While it is certainly possible to question their reports or challenge the validity of the WLI as a useful indicator, their record is nonetheless impressive and should not be dismissed as an outlier.

The substance of these charts is clear: The U.S. economy is rolling over into another recession, and the bottom of that recession lies 10 to 30 weeks in the future.

What About the Stock Market?

As previously noted, the stock market’s tops and troughs do not correlate closely with the peaks and valleys of the underlying economy, as depicted on the above charts by the WLI.

Since the closest modern analog we have to a deflationary, deleveraging economy supported by massive central bank and central government intervention is Japan between 1989 and the present, let’s turn to B.C.’s chart of the Nikkei stock index between 1985 and 2003 overlaid with the S&P 500 (SPX) U.S. stock index starting from 1995 to the present.

To make the comparison “apples to apples,” the indices have both been plotted as a percentage of their highs, and each index has been adjusted against the trade-weighted currency (yen and dollar). To insure that currency fluctuations haven’t skewed our understanding of the index’s history, the Nikkei has been plotted  adjusting to both the yen (red line) and to the dollar (blue line).

In adjusted terms, the Nikkei index topped in 1989, while the SPX peaked in 2000.


Plotted in this fashion, we see that the two indices, though based in different economies, have traced uncannily similar histories from their respective peaks.

We can see the sharp recoveries in the SPX in 2010 and 2011 when the Federal Reserve responded to market declines with massive quantitative easing (QE) programs.

Will the Fed continue to support the U.S. market with QE programs every time it sags? Will QE always work as well as it did in 2010 and 2011? If the history of the deflationary-era Nikkei is any guide (and we should recall that Japan’s central bank has provided unprecedented monetary easing while the central government has borrowed and spent unprecedented sums on fiscal stimulus), the bottom could be a year away.

In Part II: Predicting the 'When?' & 'How Far?' of the Next Market Decline, we will explore in depth the technical indicators of both the U.S. and global markets that support the probability that a lot of downward motion lies ahead before we see the ultimate bottom in both the economy and the stock market.

Click here to access Part II of this report (free executive summary; paid enrollment required for full access).

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CH1's picture

When do we hit Peak Obedience?

Not much else really matters.

DaveyJones's picture

it seems to correlate with peak pain tolerance

AldousHuxley's picture

this ain't no peak pain tolerance.


Look at north complaints there....

Chinese slave labor.....suicides rather than protests.


Humans can take a lot of pain. but it is best not to test it. Instead challenge your elites and their dogma that money does not equal merit in top 1%.



Anton LaVey's picture

North Korea and China are countries without democratic tradition and a military/security apparatus that blindly obey the commands of the dictators.

Most western countries, at least, know what freedom is... and even the most hardened military veteran knows when he is getting shafted.

Already, in some countries in Europe, policemen have been known to join protesters. Think about that for a second "Aldous Huxley".

DaveyJones's picture

Thanks for the comment. I think about this phenomenon all the time having been on both sides of the criminal court isle. Does our "tradition" make all the psychological difference? Are they moving slowly enough to conditions us? Seems pretty fast to me.  

Mrmojorisin515's picture

please, no more charles hugh smith, he makes a good point over and over and over and over...........

CommunityStandard's picture

+1  ... though ZH cannot support itself on Snorgtee girls alone

Bam_Man's picture

... and Sugar Daddy "Dating Service" ads.

LedMizer's picture

For the longest time I had "win lunch with Obama."

I'd pull a GWB and puke in his lap. 

Chaos_Theory's picture

I want to win that so I can try and see the strings attached to the arms, legs and head and see who holds the marionette's control bar.

john39's picture

there is also more than one version of the obama puppet if you look closely.  check out the scars on one of them....  major reconstruction work done there.  hmmm.

Iwanttoknow's picture

John 39, now that you mention it, vatic project ran a stoty about a year ago.there were photos of BHO, with scars over parieto-temporal areas.Could'nt tell whethet it was photo shopped or not.

Jack Sheet's picture

and Warren Assface Fuckitt's 10 best stock picks

LawsofPhysics's picture

Until people actually start listening and acting, good points will have to be made over and over.

on that note, where is John Corzine?  Prosecute the fucking fraud already.

JohnKozac's picture

L/P, does Corzine get $3,000 for a "thingamajig" also?

I hope not. Lets make him suffer.

GeneMarchbanks's picture

Dumb title, severely subjective material presented objectively, charts that haven't context.


old naughty's picture

but, but, it says they have still loads of BS to feed us sheeples (eh, muppets, sorry)  for another full year, OMG.

Jack Sheet's picture

But Martenson is so intellectual

Jack Sheet's picture

GM  - still wondering what the orifice in your avatar represents (no offense)

GeneMarchbanks's picture

Too late offense taken. Deep & personal. Nothing but a Mandelbrot set. I like the purdy blue.

Plain enough for you?

ps Long Live King €!

Jack Sheet's picture

Many thanks, I'm now enlightened ! It's fractal reserve banking.

Umh's picture

did not break down until September 2009,

should be

did not break down until September 2008,

kito's picture

the bottom could be a year away...

there is no bottom to a box that blows up.......think outside the box charles......a whole new paradigm is inching closer.....we dont give a crap about bottoms under the old system....nobody in their right mind cares about "getting back in" at the bottom of the same broken system................

Seer's picture

Yeah, nothing like trying to operate under an old play-book when there's a new game on.  All this cycle forecasting stuff is pure crap- the future won't be what it once was...

Henry Chinaski's picture

What good are charts in uncharted territory?

mayhem_korner's picture

Clearly, the correlation between market action and the underlying economy is weak.


Markets are decoupled from underlying economy (because there is no scarcity of fiat that can be allocated to paper investment, whereas the actual economy inherently reflects how scarce capital is allocated).  Check

Maintaining the flow of fiat is not reliant upon economic activity.  Check

Therefore, there is no compelling reason for the correlation between market action and the underlying economy to strengthen.  Check

So why the conclusion that the market is going to catch up in 10 weeks, 30 weeks, or ever?


michael_engineer's picture

Markets may be uncoupled but true capital is always coupled to the flows of natural resources, cheap energy, food, rare earths, etc that are input to the economy.

LawsofPhysics's picture

Correct.  Take away the input and it's game over.  The spice must flow.

tlnzz's picture

 This is what you have when the Government does everything they can do for Wall Street at the expense of destroying Main Street. Retribution will be forth coming. Ready the pitch forks.

dizzyfingers's picture

"Ready the pitch forks."

Guillotines are better.

mayhem_korner's picture my book, there's nothing like the heft of a fresh spearing on the end of a four-pronger. 

'scuze me while i get back to fermenting my corn liquor

slewie the pi-rat's picture

'the bottom could be a year away.'

what a fuking clown show today, tyler!

GeneMarchbanks's picture

HEADLINE: Martenson material could easily lead to Peak ZeroHedge.

Spastica Rex's picture

It's better than the modular hurricane flood lifeboat "story" from yesterday.

crawldaddy's picture

we all know how this ends.  The Schrute buck takes over.

blunderdog's picture

In order for capital allocation guidance to FAVOR investment in "real" economic activity, the paper economy has to be completely destroyed. 

We've got quite a ways to go on that.

As long as it's easier to make money gambling on teetering index prices, nothing in the world of production is going to change.

mrktwtch2's picture

after 911 the economy stalleed but came back then the bankers proceeded to do more damage than those rag heads ever did to the economy..and how many have been aressted??

Hedgetard55's picture

The real question is who is juicing Farcebook the last few days and why?

bigwavedave's picture

its the safe haven trade for 2012

Disenchanted's picture



In a short time we'll see them(or their agents) on CNBS or Bloomsplooge TV telling the Muppets how great an opportunity FaceFuck is this time(pumping and dumping). No really, trust us it will be different now.

A Lunatic's picture

When I see mushroom clouds on the horizon, the townsfolk looting, pillaging, and burning their habitats, and the stock market at 18k I'll know the bottom is only a few more months away.

who-is-john-galt's picture

The outcome is all predicated on a free market and when was the last time we had one of those?

GeneMarchbanks's picture

-1 for flagrant use of mythology: free market

who-is-john-galt's picture

Is that a flagrant 1 or flagrant 2 with immediate ejection?

carbonmutant's picture

The Bottom will occur when Bernanke is replaced.

El's picture

Of course the Fed will bail them out. Let's look at the alternative. If the Fed allows the banks to fail, then the Fed will be no more. These guys are into self-preservation just as much as they are into transferring wealth. Maybe if it were only one or two banks...but the issues we have are systemic throughout.

DosZap's picture

-1 for flagrant use of mythology: free market

Maybe he meant to say, Flee market.