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Guest Post: Yield Spread Confirming Recession Call
Submitted by Lance Roberts of StreetTalk Advisors
Yield Spread Confirming Recession Call
Recession. It is now becoming clearer, even to the mainstream media, that the "Big 'R'" is rapidly approaching, or already upon us. Without further stimulus from the government the economy will continue its slide into negative growth. Unfortunately, it doesn't look like the "Calvary" will be charging to the rescue anytime soon. Bernanke, at this point has effectively punted to the Whitehouse for stimulative action. The Whitehouse is embroiled in partisan politics which will keep any action from occurring until most likely after the next election. This leaves the economy and the financial markets to their own devices, and much like kids without parental supervision, they are running amok.
I have been very vocal as of late commenting on the fact that a recession is fast approaching. The trends of the economic numbers have all soured to the negative. From manufacturing to personal incomes to sentiment they all are signaling a recession lay ahead. Another confirming indicator of a recessionary track is the spread in yields between junk bonds and high quality bonds. The chart here shows two different yield spreads. The blue represents the difference in yields between AAA rated corporate bonds to BB rated bonds while the red represents the spread between 10-yr government treasuries to BB rated bonds. The dotted horizontal lines represent when these spreads have signaled recessions in the economy.
When the economy is strong the spread between BB (Junk Bonds) and AAA Bonds or Government treasuries is much lower as the perceived risk of default on payment is lower. In times of economic stress or recession the perceived risk of default or failure is much greater. Currently, spreads at these levels are very indicative of economic stress and recessions. The perceived risk of corporate failure is rising and spreads are widening as money leaves high risk bonds (driving interest rates higher) and moves to safer yielding bonds (keeping rates lower). The wider the spread the harder it is for weak companies to access capital and corporate failures rise.
On Friday, Lakshman Achuthan of the Economic Cycle Research Institute reviewed the weight of ECRI's research, observing "Now it's a done deal. We are going into a recession."
The spread in yields combined with our own research as well as that of the ECRI, which is a very conservative organization with calls generally way ahead of the consensus as we have repeatedly been, confirms that our views are most likely the correct one.
While the media tends to view the economy from one report to the next what is important is to understand the trend and the balance of the data on the whole. Understanding the trend and balance will make you very unpopular with the rest of the world that consistently ops for the "glass half full" view but will keep you from losing a lot of money in the long run.
John Hussman summed this view up well; "In contrast, good economists think about the economy as a system - where multiple sectors interact. We tend to use words like 'equilibrium' and 'syndrome' when we talk about economic data - emphasizing that the best signals involve a whole conformation of evidence, not one or two indicators, where the data - in combination - captures a particular signature of recession or recovery.
Look at how Achuthan described the situation on CNBC on Friday, and you'll see a good example of this sort of thinking:
'This is a done deal. We are going into a recession. We've been very objective about getting to this point, but last week we announced to our clients that we're slipping into a recession. This is the first time I'm saying it publicly. 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.. These leading indicators, which are objective.. they have a certain pattern that they present in front of a recession, and that is in, that is in right now.'
'A recession is a process, and I think a lot of people don't understand that; they're looking for two negative quarters of GDP. But it is a process where sales disappoint, so production falls, employment falls, income falls, and then sales fall. That vicious circle has started. You're looking at the forward drivers of that, which are different indicators - there's not one - everything's imperfect. The Weekly Leading Index .. that is saying unequivocally, this is recession. Long Leading Index, which has a longer lead, is saying recession. Service sector indicators, non-financial services where 5 out of 8 Americans work, plunging. Manufacturing, going into contraction. Exports, collapsing. This is a deadly combination, we are not going to escape this, and it is a new recession.'
For investors, if you believe that current analyst estimates of forward operating earnings are correct, and you believe that the inappropriate bubble-era benchmarks for price-to-forward operating earnings are actually valid, and you've ignored all evidence that the Fed Model is spectacularly devoid of validity, and you believe that the only course for valuations is to move toward those misguided benchmarks regardless of what happens to Europe or the U.S. economy, then it's easy to believe that stocks will head higher. For our part, we believe none of those things..."
We agree with John on this point. These are points that we have written extensively on in the past. In a low growth economic environment the persistent call for high growth rates in stock prices is dumbfounding. History tells us that the corporate earnings, and ultimately capital appreciation, cannot grow faster than the economy for long. Corporate earnings, and ultimately the prices paid for those earnings, are a reflection of the economy and not vice versa.
There is one final key point to all of this as it relates to the yield spread. Investors face not only an oncoming recession here but also a probable sovereign default and recession in Europe. The compounding of these factors translates into heightened credit risk here in the U.S. (as noted by credit spreads jumping higher recently) and corporations do not borrow at the 10-year treasury rate. They borrow from the bond market and the rising costs of borrowing due to rising credit risk impacts corporate profitability. Expectations for earnings growth going into 2012 is still extremely high with current estimates sitting at an all-time record for the S&P 500 index next year. The reality of that occurring is almost nil. In turn, this means that prices will have to be adjusted for the reality of a recessionary economy which is why the average decline of stocks during a recession is about 33%.
John Hussman summed our current stance up very well: "Still, as always, we're data-driven, and there are possible combinations of evidence (not in hand at the moment) that could move us to a modestly or moderately constructive investment stance even in the context of broader economic risks. My impression continues to be that the best hope for a sustained advance (early on, probably only several weeks or a few months in duration) is from substantially lower levels, but we'll take our evidence as it comes. Suffice it to say that we remain defensive here, but are quite willing to shift our investment stance if the evidence supports that." Well said.
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So what's the next "recession" going to be called? "The Great-Great Recession"? How about "The Really Great Recession"? We all know here that we never escaped "The Greatest Depression," and it just continues on.
Gold and Silver, Bitchez!
The Recession Strikes Back
"Back to the Past"
Agreed, we never left the first recession. Hell, we never left the S&L crisis. All we did was kick the can down the road by deregulating banks, keeping interest rates low and flooding the marketplace with credit. By easing lending standards, future demand was brought forward. Is it any suprise consumers aren't spending? We've bought everything we need and more.
The result of credit expansion was a gross misallocation of capital toward idiotic ventures like flipping homes. A return to normalcy will lead to chaos, because there is a generation of people who have no clue what putting 20% down on a house means.
Nothing materially has changed since 2008, except that the banks have continued to play Fantasy Land with their accounting standards. They need to go to hell.
It doesn't have to come to pass. phone your representative and ask them to seriously consider Obama's fiscal stimulus plan. It can provide a stop-gap until after the 2012 election.
The problem with the US is that it distorts economic policies for a 2 year revolving election schedule. So the policies are always sub-optimal. China, and other countries have a 5 year plan.
That statement is funny in so many ways. From Obama's plan to it saving us to phoning our representatives as if it matters. Now you're just being ridiculous.
you're being ridiculous for living in a democracy and believing you have no agency over the circumstances of your life. you could head out to your representative office, and freely speak your mind, and demand fiscal stimulus.
In so many other countries, you'd be detained, or shot for even trying to effect change.
The belief that spontaneous collective organizing doesn't effect change is what undermines the political organum.
#occupy wallstreet
Better to be a rebel, than a slave.
Go back to your "DormRoom," kid. You know nothing about the real world.
you mean the real world in which an Tunisian vendor's self immolation causes the overthrow of decades old authoratative regimes in the middle east, and north africa?
That real world, where ppl are angry enough to self organize, and demand change through daily civil disobedience, rather than anemically voting one day once every 2, and 4 years.
That real world? The real world is the world you actively participate in. I have 80 years left on this planet. I'd like to have some optimisim for such a long journey.
I apreciate and applaud your optimism - I'm an old guy, and reality has sunk in, but I'm glad the youth still believe.
I have contributed to my congressman's campaign chest.
I have written to him, and got form letter replies.
I have spoken to some of his staff people - I did not contribute enough to speak to him.
Ahh, kid - HE DOESN'T GIVE A SHIT ABOUT ME OR MY OPINIONS, AND NEITHER DOES ANY OTHER CONGRESSMAN or SENATOR.
FOR God's sake - that's why there is an 'Occupy' movement - most of those folks understand that they are not listened to. You are talking out of both sides of your mouth if you say "Write or call your elected reps" and then say in the real world people are demonstrating for their rights. Make up your fucking mind.
Writing or calling your elected reps does not mean a damn thing, EXCEPT, sometimes, on the most local level - like your rep on the city district or county district you live in - and that is only if you get to know the person individually and personally - it helps if you work, even a little, on their campaign or are involved with a local group (voters!).
I've been involved in local politics for 40 years plus - trust me kid, the only politics that work for you personally are the very local ones - once they get out of town, you are NOBODY, unless you contribute a LOT of money to their campaigns.
Sorry about that.
You have 80 years left on this planet?
What are you like 3 years old?
They way things are going, you may be lucky to have a few decent years left before our standard of living is on par with a second or third world country.
I do agree with the sentiment that we CAN affect changes, but the populace needs to be a lot hungrier and angrier before that happens.
And it unfortunatly will take hunger. Been saying that for years. Only thing that really pisses people off is not being to feed thier kids.
That's when the thin veneer of civilized society breaks, and the SHTF in a monumental way.
It's comng faster and faster at this point.
Be prepared.
He's been huffing the chloroform that his roommate swiped from the chemistry lab stockroom.
The cops are detaining people in NYC. Displaying their faux machismo as they randomly spray defenseless women on the sidewalk. How long before they put a couple of caps in someones head?
Many of them have been raised on a steady Fox diet of "kill the liberalz"...
we'll have to wait and see
Dormroom- Then please explain why Ron Paul, the only candidate whose beliefs are based in some reality, is constantly marginalized and ignored by the MSM? The reason is that the current parties support the current system and are afraid of anybody that espouses change to the status quo. This is why he is getting almost no air time and is relegated to the sidelines in any commentary regarding 'front runners'. What a farce.
Dormroom, you are a clown.
bringing out the weapons-grade stupid again. awesome.
Stimulus is a joke! You need real economic productivity not money printing and low interest rates that starve the widows and responsible people who've saved and not spent 10 years into the future. Get off the liberal bandwagon and use your common sense to see how crazy your statement is!
Are the Occupy Wall Street people really pro-Obama like "dormroom?" If so, they are totally clueless.
Hey DormRoom: The Obummer-Bot
You have been reading this blog for 1 year and 44 weeks and you still have not learned anything?
It is time for you to change from Econ/Poli Sci "I wanna be a lawyer/ass-bite politician" double major...
You are hereby ordered to take symbolic logic classes and upper division mathematics until you learn logically valid reasoning...
Recession II: Electric Boogaloo?
Well played.
Dumpsterdivingnation ?
Recession 2 Electric Boogaloo
^ By far my favorite. +1.
Dear Lance,
Going from Depression to Recession is an upgrade, hence your precious charts and paragraphs are really redundant.
PAYDAY IN GREECE!
The U.S. approved to grant 400 M1A1 Abrams to GreeceOctober 3, 2011
BOO-YAH!
Reference?
If true - maybe to blow parliment up.
Remember, this is a giant turd. It's turtle heading right now. Whether this is just to scare everyone into squeezing harder or the beginning of the inevitable O-ring tearage is anyone's guess.
"The Whitehouse is embroiled in partisan politics which will keep any action from occurring until most likely after the next election." Duh! I don't think so!:)
"entering a recession" - Ha, ha. Adjusted for monetary inflation we have been in negative growth for years!
Cavalry? You want some cavalry? Then you'll get bear cavalry and you'll like it.
http://nerdfighters.ning.com/photo/bear-cavalry-2
I was trying to figure out if the use of "Calvary" in the text was an intentional Christological allusion, or just the common mispelling of cavalry.
Just a nice Freudian slip in my Book.
The "quotes" didn't help either, but I jumped over it. Because it's BEAR CAVALRY!!1 FTW
Some guy in Pa got 70 stitches from the Bear Cavalry when a bear followed his dog in the back door at 3am and chewed his scalp...
Perry County bear attack victims speak about terrifying ordealk
Recession?? Oh noes! Who could have seen this coming???
Still cannot come up with the Cajones to say Depression.
ORI
ORI, Depression is so 1930's. It's now referred to as 'severe economic downturn'.
Hmmmmmm...... it does have a rather "Kinetic" ring to it, I have to admit.
ORI
We're economically "right-sizing".
+1...
"Still cannot come up with the Cajones to say Depression."
Allow me: Depression...
Perhaps this is even easier to say:
fucking depression
QE5 will be here in no time.
True enough.
Not much time and probably a a couple hundred s and p's from here....the markets need to waterboard our leaders first until they beg for more funny money. Soiled britches and all.
Geez, who knows? Will probably get a bank holiday, a couple more banking casualties, too....
JP Morgan- Chase- Morgan Stanley- Dean Witter-Sachs.
Lead - with little copper dinner jackets, silver, food, claymores, firewood, solar power, and a community of like minded individuals, in that order - new age new world investment strategy.
The claymore factory is where it is at. Invest for the future.
No, NO. Community first! Then the lead and the rest.
Let me guess. No one could have seen this coming?
LOL
"Unfortunately, it doesn't look like the "Calvary" will be charging to the rescue anytime soon."
Calvary was that hill outside of Jerusalem where JC got nailed to the cross. Is that what you want or want the the troopers on horseback to be riding to your rescue?
Bank of Apocalpytic Collapse website still down as of 2:09 pm est.
Pobably will anounce that the $5 fee was just a joke before the site is up again.
Yes
No
Will the DOW drop below 10,000 this week?
Perhaps, but most likely only by the end of October DJIA will be stable under 10000. It is not a collapse that is happening today, just the unwinding of effects of QE2. Predictable since beginning of QE2:
http://saposjoint.net/Forum/viewtopic.php?f=14&t=2626&start=0#p30485
The mistake in this February 6th chart today is 0%. Its spot on within the thicknes of the line I used to draw it.
However, long term picture with deflationary recession in the USA does not look good for DJIA stocks nor recession:
http://saposjoint.net/Forum/viewtopic.php?f=14&t=2626&st=0&sk=t&sd=a&sta...
So its deflationary recession till end of 2014 ( I have longer term predictions, just finetuning them, up to 2015).
After that , in 2015 the USA default on debt, and inflation. That might help to go out of recession, might cause ( even before the default) some wars.
The interesting thing now for me is to predict how much and when vs, what currencies USD will appreciate, meaning that those currencies will buy less and less oil. Will they tolerate it or try to increase the values of their currencies somehow (e.g. China moving to silver standard?)
More on currency rate forecats later. Clearly , USD will appreciate almost against every currency in 2012-2014, being a reserve currency and mother of the USA debt that pays for everything. It has already started.
Maybe.
I have a strong opinion about that.
Actually, it doesn't make any difference. The PPT(Plunge Protection Team) will hit the gas as needed to get desired results. It happened today. A 400pt swing to finish +155 in the last hour? Pleez. On top of that, if the Dow went to 15k, what would your portfolio be worth when the dollars is bleeding daily. It's a racket folks.
Actually, it doesn't make any difference. The PPT(Plunge Protection Team) will hit the gas as needed to get desired results. It happened today. A 400pt swing to finish +155? Pleez. On top of that, if the Dow went to 15k, what would your portfolio be worth when the dollars is bleeding daily. It's a racket folks.
Confirmed double-dip = America's Second Great Depression.
We are sooo close it is both sad and deserved. The American people will not put a stop to anything until 40%+ of their incomes go towards eating and staying alive. That is what set off Egypt duirng the Arab Spring.
Benny boy was looking very nervous today. He knows what his legacy will be... Ben S Bernanke, PhD, Doctor of America's Second Great Depression.
I really hope the term 'double dip', as used to describe the current never recovered from depression, dies the same death as 'green shoots'.
Dibble Doup?
"The Double Douche..." - Sam Elliot in Roadhouse.
but he has an exit off of I-95 named in his honor. Ben Bernanke Interchange. I almost ran off the road when I saw that sign announcing the exit for Dillon, S.C.
Needs some Krylon obviously......
fits... swamp and snake country...
All this is is more whining for QE3. Had the market been allowed to flush out all of the dead weight back in 2009, we would not be in the position that we are now in.
Any illusory effect of QE3 would be met with ramped up protests.
Regardless, let loose the HFTs and drive the market down into the brink of oblivion.
"Recession. It is now becoming clearer, even to the mainstream media, that the "Big 'R'" is rapidly approaching"
....had to point out this error......I think you meant to state the following:
"Depression. It is now becoming clearer, even to the mainstream media, that the "Big 'D'" is rapidly getting worse"
why call it a depression when you can call it a recession?
Trust me, this will not be called a "depression" until the most important peoples behind the money have secured their escape routes. Even then, it might still be called a recession. I say it'll probably take another 10 or so years before it's called for what it is. By that time, the rats will be long gone.
And yet today in congress there are trying to pass more free trade agreements with central america and asia. America is lost.
Because trade is a bad thing. Why they might underprice us if the government didn't force us to buy American. And besides America can't compete. We are through. Might just as well throw up a wall and die quietly.
Say. Is this a markets/economics blog?
Buy Low. Sell High. Bichez.
Or you could sell high, buy low. If you are in to that sort of thing.
personally of the opinion that the stock market and the economy have decoupled. the last time it happened THEY came to us for money to bail THEM out, which had a negative effect on the REAL economy, but nothing to do with the business cycle, and zero to do with the structural problems with the economy (which they were profiting from, by exploiting global imbalances)
in the final outcome there was still plenty of cheap foreign goods
the housing industry (more of a service than a manufacturing industry) took a hit
once they had bled the public (taxpayer) they started cutting public jobs, which had an even more dipilatory effect, (neither one of those things has much to do with the jobs industry creates, or the jobs industry does not create, and was an entirely assymetrical attack on the economy) but still there were plenty of cheap foreign goods, even after the housing construction industry crashed, and the public sector was downsized.
frankly there is not much more damage they can do to the real economy, if we refuse to bail them out of their financial engineering woes, which really pay their bonuses and profits, and do nothing for the rest of us. if only we wouldn't let them have OUR money.
Could we please stop saying "negative growth" and call it what it is, "decline".
No we can't. We like messing with you that much.
Jeeez.....I wonder.....? Who might be selling paper PMs in order to prop their own stock....and, all the while, Jam People More?
How about we end the BULLSHIT? What do you say?? This is not a fucking Ressession, its a Depression and everyone with a brain knows it. Enough with the games!!
<< DXY > 82 before S&P < 1,000 (and Ben starts up the printer)
<< S&P < 1,000 before DXY > 82 (and Ben starts up the printer)
sux bitchez
Calvary?
Okay, look, you are a poster -- Calvary is a crucifixion site; cavalry refers to mounted soldiers.
Perhaps you meant to say that no crucifixion is coming, I don't know.
Point of information. That should read "Cavalry" not "Calvary" (sic). Unless of course you were wishing divine intervention?
Oops, just noticed the earlier post above. Same issue though.
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