Economy

We’re Going into Recession Soon

They say nobody rings a bell at the top of a stock market rally, but here goes nothing: in my view, the US economy is rolling over into recession and the stock market is about to enter a multiyear (1-3yrs) period of subpar, and perhaps even terrible, returns.

Am I certain of this? Of course not. Nobody can be when discussing the future. But I’ll lay out my case here and let you decide for yourself whether you agree.

Coincidentally, today marks the 10 year anniversary of the start of the current bull market in the stock market, making it the longest ever. The bottom of the 2008 Financial Crisis bear market was March 9, 2009. Here is a look at how the market has done since:

Screen Shot 2019-03-07 at 1.06.21 PM.png

Ten years is a long time. The market has to drop eventually. In my personal opinion, the drop is fairly imminent (i.e. within the next 12 months).

Importantly, a major chart formation known as a “head and shoulders top” seems to be forming right now.

Here’s a closer look:

Screen Shot 2019-03-07 at 1.28.57 PM.png

From Investopedia:

“A head and shoulders pattern is a chart formation that resembles a baseline with three peaks, the outside two are close in height and the middle is highest. In technical analysis, a head and shoulders pattern describes a specific chart formation that predicts a bullish-to-bearish trend reversal. The head and shoulders pattern is believed to be one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.”

As I always say when I discuss the stock market, chart analysis is really an analysis of investor behavior and sentiment. It’s much more than lines and numbers. The chart can tell you a lot about what investors are thinking.

What we’re seeing is investors unwilling to buy stocks at the same prices they were back in August 2018. In order for markets to keep ascending, investors need to want to continually pay higher prices. That’s no longer happening.

Right now, we might be at the top of the right shoulder, which means it would be the last best chance to sell before a major drop.

Going forward, two things can happen: the first is that the market blasts off and reaches a new high, meaning higher than the “head”. This would of course invalidate all the “head and shoulders top” talk because the right shoulder would not actually be a right shoulder.

But the second thing that can happen is the market declines over the near term. This  would confirm the head and shoulders top formation and indicate a major drop in the market is incoming. If we see the market roll over and confirm the head and shoulders top, run for the hills.

As far as the economy, there are a few things that lead me to believe we’re going into recession. Again, I have to say, I could be wrong. In fact, I hope I am; a recession would be terrible for everyone. And also I have to add this is not a recommendation to buy or sell stocks, but I will be looking to cash in my stocks in the near future. I want to sell early rather than later. That’s the whole point. This is a personal decision and doesn’t mean you need to do the same, but I’m sharing with you my personal decisions because I despise stock market articles where they make a bunch of predictions and yet the authors never actually disclose what they’re doing with their own money.

Anyway:

  1. GDP is slowing down. 2018 was a strong year for GDP. We saw the first year of 3% growth in a long time, like Trump promised. But now things are slowing considerably. The Atlanta Fed, which tracks GDP, foresees the economy growing at just 0.3% in the first quarter of 2019. 0.3% is not negative, but things are heading in the wrong direction. Two consecutive quarters of negative growth mean we are officially in recession.
  2. My dad works in the automotive industry and says he sees signs all over the place that the economy is slowing down. And indeed recent headlines have confirmed that auto sales are slowing down this year. Carmakers are trying to project optimism by blaming the slow start to the year on the cold weather, but the slowdown is more of a long-term thing: “However … the results today suggest a much bigger story: The sales pace has finally shifted into a lower gear.” Declining automotive sales equal a declining economy. When consumers are tightening their belts, the last thing they want to do is buy cars. Those are purchases that can wait until things get better. This is why automakers get hit hard when the economy declines.
  3. US household net worth fell by 3.5% (over $3 trillion) in the fourth quarter of 2018, the largest quarterly fall since a 6% loss in late 2008, when the economy was in the midst of its worst crisis since the 1930s. This is not good.
  4. The treasury yield curve inverted in December. Wall Street freaks out when this happens because it almost always precedes a recession. Basically what it means is that short-term interest rates have become higher than long-term interest rates, and this is not normal. Investors sell short-term government bonds and buy long-term bonds in a flight to safety. The last time there was a yield curve inversion prior to the one in December 2018? 2006. A year later the Global Financial Crisis began.
  5. The Russell 2000 stock market index, which tracks small-cap stocks, is already basically in a bear market. At its peak in August, it hit a level of 1,740. At its recent low in December, it hit 1,292, meaning it was down 26% from highs. Currently it sits at 1,523, still 12.5% lower than its record high. The small-caps index is a leading indicator for the major indexes like the S&P 500, Dow and Nasdaq, which track larger, more established companies. In other words, the Russell 2000 is going to break first, because in a recession, the smaller companies are going to go down before the larger, more established companies. Right now, we’re seeing a breakdown in the Russell 2000, which means the bigger companies are next.

On top of these US indicators, there are signs around the world of a slowing global economy. The European Central Bank just cut its Eurozone growth forecast to 1.1%, down from the previous forecast of 1.7%.

In Japan, the Nikkei is down 12% off its August highs. At its low point in December, the Nikkei was 21% below its August peak, officially a bear market.

The German DAX Index is 13% off its peak, which actually happened in May 2018. The DAX has been in a decline for nearly a year. At the DAX’s low point in December, it was 22% below its May highs.

We even saw a brief bear market in the Nasdaq here in the US in December, with the index recording a decline of 24% from its August record high. Right now it sits about 9% below its record high.

Relatively speaking, the US markets are still in decent shape compared to the rest of the world. At the December lows, stock markets in China, South Korea, Turkey, Italy and Mexico were in bear markets, in addition to those in Japan and Germany.

Economic expansions/bull markets rarely last as long as this one. A major reason this current period has persisted so long was zero-percent interest rates and quantitative easing, but now those Fed policies are long gone. I believe Trump prolonged (and, more importantly, improved) the Obama expansion for as long as he could, but eventually the party has to end, and it now appears it is.

I’m not urging you to dump all your stocks. That’s up to you. Make your own decisions. Do your own research.

But I am selling out now while my portfolio is up.

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