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Stock Markets Plunge, Concerns Abound - Recession?

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

January 19, 2016

IN THIS ISSUE:

1. The Case For a Global Recession in 2016

2. European Sovereign Debt Crisis is Worsening

3. The Growing Case For a US Recession in 2016

4. Hulbert Predicts Stock Plunge Will End Soon

Overview

The first half of January 2016 has been the worst New Year’s opening for the US stock markets in history. Yet nothing much has changed economically since the end of last year. So why is the Dow Jones down 8.24%, the S&P 500 down 8.00% and the Nasdaq down 10.36% in just the first two weeks or so of the New Year? The answer is not yet clear.

According to the Stock Trader’s Almanac, if US stocks move lower in January, that means a down year for equities 75% of the time. While January is not over yet, it’s hard to imagine that stocks could close up for the month. So are we looking at the first down year for US stocks since 2008? Time will tell, but it sure looks that way.

Questions abound. Did the Fed make a huge mistake by raising short-term rates by a mere 0.25% in December? Did news that China’s economy grew at only around 6% last year and may be slowing more this year upset the global apple cart? Are plunging oil prices really a bad thing?  Is a new global recession just around the corner? Should we be preparing for a new recession here in the US this year?

These are the questions everyone is asking in the wake of the plunging stock market prices we have seen from the beginning of 2016. It is true that the current economic recovery which began in 2009 is the weakest in more than a half century, but this is nothing new. Rather than negative growth, GDP has expanded only by about 2% since Obama took office.

Yet the Fed’s latest estimate of 4Q GDP growth has now fallen from 2.0% on December 17 to only 0.6% in the latest GDPNow estimate in the second week of January. This economy is losing momentum fast. The risks of a recession this year are quickly increasing. This may help explain why equities are tanking so far this year.

There’s so much to talk about today, I’m not sure where to start. Let’s begin with the case for a recession this year, both globally and here at home.

We’ll end on a positive note from Mark Hulbert, editor of the Hulbert Financial Digest, who suggests that this latest downward market correction may be over before too long. Let’s get started.

The Case For a Global Recession in 2016

Increasing signs suggest that we may be on the verge of another global recession. Patterns in economic data are showing signs of weakness, and the troubles persisting in Europe and the bubble bursting in China may be the triggers that send the global economy over the edge this year.

China’s stock market indexes have plummeted more than 40% since the middle of 2015 as the nation’s once-booming export and investment driven economy is weakening. Around the world, factories and businesses that were built to satisfy China’s insatiable demand for raw materials and capital goods are falling silent.

Shanghai Composite

Unlike in 2008, when central banks were able to slash interest rates and expand their balance sheets, central banks now have much less room to enact loose monetary policy to prevent a global recession from unfolding this year.

Recessions are a normal part of the macroeconomic cycles that the world experiences, and happen from time to time. The last recession was seven years ago so the global economy is due for another slowdown. Signs increasingly suggest that the next global recession could be right around the corner.

Several parts of the global economy have already turned down, including Russia and Brazil among others. Russia has serious problems related to plunging energy prices and economic sanctions. Brazil is already in a recession, and most of South America appears headed there also. Similar slowdowns are occurring in other parts of the world as well.

European Sovereign Debt Crisis is Worsening

The sovereign debt crisis that followed the Great Recession in Europe has been a persistent issue, and Europe represents a significant part of the world economy. The European Central Bank (ECB) has also taken the extraordinary measure of implementing “quantitative easing” in the Eurozone in an effort to stimulate growth.

The so-called PIIGS nations (Portugal, Ireland, Italy, Greece & Spain) have been bailed out repeatedly by the European Union and the IMF, with mandatory austerity measures imposed on their populations. Not only has austerity been unpopular, such measures have also reduced consumer spending.

The worst of the PIIGS has been Greece, which defaulted on an IMF loan last year. Even though Greece itself represents a relatively small portion of the Eurozone, the fear is that if Greece leaves the European common currency, other PIIGS countries will follow. This could lead to a collapse of the euro and a new global financial crisis.

What you probably haven’t heard is that Italy is teetering on the brink of another financial crisis. Many of Italy’s banks are in trouble, and non-performing loans reached at least $216 billion at the end of 2015, which is apprx. 17% of Italy’s GDP.

Several Italian banks unexpectedly failed last year and that number is expected to increase, perhaps significantly, in 2016. In the recent spate of bank closings, reported 130,000 shareholders lost almost €800 million.

With interest rates near zero, Italians have been increasingly investing in bank bonds the last few years to get at least some return. The total amount of bank debt held by Italian households is reported to be almost €238 billion. That’s billion with a B. Think of it as high-yield debt on steroids – except that it is generally very low-yield.

While the four small banks that failed represented just 1% of total Italian bank deposits, Italian bank debt is now very suspect. In Italy, bank depositors are covered up to €100,000 but many businesses and wealthier households had much larger balances and actually saw most of their money in those banks disappear.

For sure, we want to keep a close eye on Italy’s banking system this year as it could easily escalate into a financial crisis very quickly. Yet we hear almost nothing about it in the financial media. What else is new?

The Growing Case For a US Recession in 2016

Let’s see – stocks are diving, retail sales are slumping and economic bellwether Wal-Mart says it will shutter 154 US stores this year. Meanwhile, China's markets are in free fall. Is it too early to mention the “R” word? Maybe, maybe not.

On the bright side, US jobs growth continues to surprise on the upside. Payrolls increased an average of 230,000 jobs a month last year – and the decline of the unemployment rate to 5% are both positive signs.

But not everything is going so well –  starting with the stock market as noted above. The S&P 500 and the Dow are off to their worst New Year’s start ever. USA Today says that $2.3 trillion in shareholder wealth has been wiped out so far this year – a huge hit that will be felt across the economy.

Even before the market decline, however, clouds were gathering. Retail sales fell 0.1% in December and were up just 2.2% year-over-year. And Friday's announcement by Wal-Mart that it's closing 269 stores worldwide – 154 of them in the US – can only be bad news.

For the US, that was a lot of lost momentum going into the New Year.

The Atlanta Fed’s widely followed gauge of current economic output suggests 4Q annualized GDP growth of just 0.6% as of last week, and the trend is very troubling.

GDPNow

Despite that, most economists think the American economy will continue to expand, but weakness abroad is heightening their concern about US growth. Forecasters in The Wall Street Journal’s latest survey of 76 economists say there is a 17% chance (on average) that the US will enter recession this year, the highest risk in three years.

Yet as long-time readers know very well, mainstream economists are almost always too optimistic in their forecasts. And they apparently know it. In the same WSJ survey last week, almost 80% of the same forecasters said they see risks to the economy to the downside, if they are wrong. Put differently only one-in-five believes the US economy will surprise on the upside in 2016.

So, yes, as we start 2016, a recession is a real possibility, especially in light of the deterioration in the Atlanta Fed’s GDPNow estimate shown above. Add to that the likelihood of three or four Fed rate hikes this year, and the chances of a recession this year increase significantly.

As I detailed in my BLOG last Thursday, numerous Fed officials have been tripping over themselves to hint that the four more rate hikes planned for this year are not likely to happen. Given the plunge in equity prices this year, and the increasing likelihood of a recession in 2016, I will not be surprised if it’s “one-and-done” for the Fed.

Hulbert Predicts Stock Plunge Will End Soon

As stated in the Overview above, we’ll end today’s letter on a potentially positive note. I think it’s fair to say that no one predicted the severity of the decline in equities that we have seen so far this year. And since virtually no one predicted it, few have any idea how severe it will be.

Yet with that said, financial writer Mark Hulbert, editor of the HULBERT FINANCIAL DIGEST, has some interesting data on when the current plunge might end. Hulbert has made a name for himself over the years by tracking the performance numbers for investment newsletters, and he writes about various investment and market topics of the day.

Mark published a column last Friday entitled “[The] Bear Market Will be Over Before You Know it.” He always has some interesting statistics that most of us have never heard of or thought about. His latest column is no different.

Mark’s central argument on Friday was that by the time most investors realize there’s a bear market, most of the damage has already been done and the end will happen relatively soon. Bear markets are typically defined as a market decline of 20% or more. While the major US equity indexes are not down 20% from their highs, Hulbert decided to enlighten us anyway.

Using statistics from the reliable Ned Davis Research, Hulbert notes that the average duration of the 35 bear markets in stocks since 1900 is 403 days, or just over a year. He points out that the last market high in the S&P 500 Index occurred on June 23 of last year.

Mark points out that the downward move since June 23 of last year has covered 206 days. So based on the historical averages, we are already over half way through this downturn, which may or may not turn into a bear market.

Market's recent decline

Hulbert’s point is that if this market decline holds to the historical averages, the current decline should be over well before the end of this year. He also points out that since we’re not yet in a bear market, even more days will have elapsed by the time we get there – assuming we do – and there will be even fewer days to the end.

To his credit, Mark points out that no two bear markets are ever the same, and that averages are just that – averages. Yet he concludes:

But, not infrequently, a bear-market declaration often amounts to little more than closing the barn door after the horses have left.

We should all be asking: What were Wall Street’s latter-day bears saying last June, when the market was at an all-time high? The answer is that bears were few and far between. On the contrary, bullishness was at close to extreme levels.

None of this is to minimize the pain and suffering caused by bear-market losses. But there should be at least some solace in knowing that, even if it is eventually determined that a bear market began last June, if it’s no worse than average it’s already more than half over.

Of course, it remains to be seen just how much worse the early 2016 stock market losses will get, and whether or not we are headed for a 20% correction or worse. But as usual, Mark Hulbert gives us something interesting to think about, and a lighter note on which to conclude today’s E-Letter.

Very best regards,

Gary D. Halbert

 

SPECIAL ARTICLES

Economists: Continued US Expansion, Heightened Global Risks

6 Factors Point to Global Recession in 2016

China’s growth hits quarter-century low, raising hopes of more stimulus


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