January 27, 2023
By Steve Blumenthal
“Earnings don’t move the market; it’s the Federal Reserve Board… focus on the Central Banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”
– Stanley Druckenmiller, American investor, former hedge fund manager, and philanthropist.
Recession indicators point to an imminent recession. Let’s take a quick look at the latest data and consider the implications.
The Conference Board’s Leading Economic Index (LEI) fell 1.0% in December. The tenth consecutive monthly decline. The weakness was broad-based, with seven of the ten LEI components negative at yearend. November’s LEI was revised downward by 1.1% vs. the prior month. A larger negative revision than expected.
The six-month annualized rate of change slid by 4.2%. It was the largest drop since May 2009, excluding the pandemic.
The Conference Board noted that “overall economic activity is likely to turn negative in the coming quarters before picking up again in the final quarter of 2023.”
The Conference Board’s Leading Economic Index (LEI) and Coincident Economic Index (CEI) are indicators designed to capture turning points in the economy. Why is this so important? Among bear markets since 1946, the average stock market decline with a recession was 35.8%, according to the Wells Fargo Investment Institute. Of course, the 2000 and 2008 recessions brought us -50% (each).
Because recessions are only known in hindsight (two negative quarters of economic growth), avoiding the large stock market declines associated with recessions is important for wealth preservation.
Here are the components of LEI and CEI, followed by two charts:
Leading Economic Index components:
- Average weekly hours – manufacturing
- Average weekly initial jobless claims
- Manufacturers’ new orders – consumer goods and materials
- ISM New Orders Index
- Manufacturers’ new orders – nondefense capital goods ex aircraft
- Building permits – new private housing units
- Stock prices – S&P 500
- Leading Credit Index
- Interest rate spreads – 10Y Treasury bonds less federal funds
- Average consumer expectations for business and economic conditions
Coincident Economic Index components:
- Employees on nonagricultural payrolls
- Personal income minus transfer payments
- Industrial production
- Manufacturing and trade sales
LEI – The Economy vs. The Leading Index and Its Diffusion Index
Current state:
- The 6-month rate of change of the LEI has dropped below the level that in the past (data back to 1959) has signaled recession eight times. A recession followed each time.
- Recently, for the 9th time in the last 62 years, the 6-month rate of change of the LEI is signaling recession.
- 7 of the 10 Leading Economic Indicators list above are negative
CEI – The Economy (The Index of Coincident Economic Indicators)
Current state:
- For the 9th time since 1960, the year-over-year change in the CEI has dropped below the threshold that in eight of eight prior instances, recession followed.
- Bottom line: It is hard not to heed the warning.
Grab that coffee and find your favorite chair. Several weeks ago, I shared Ray Dalio’s Navigating Big Debt Crises (Part I) with you. He describes how he sees the mechanics and principles of the money-credit-debt-market-economic cycles working and applies them to what’s happening now. In a week or so, he will look at what is happening now and what the current situation will most likely produce. Keyword for us investors: “Navigating.” In next week’s On My Radar, we’ll channel our inner Stan Druckenmiller and focus on the state of liquidity. Hint: not so good.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Ray Dalio – The Farce and Consequences of the Debt Limit and the Debt
Ray is Founder, CIO Mentor, and Member of the Bridgewater Board
We all know that there is no real debt limit because what is called a debt limit never actually limits the debt. It’s a farce that works like a bunch of alcoholics who write laws to enforce drinking limits, and when a limit is reached, they do a farcical negotiation that temporarily eliminates the limit which allows them to have the next drinking binge until they reach the next limit at which time they go through the next farcical negotiation and continue to binge. I gather that this is the 79th farcical negotiation that has taken place.
Not only does this tragically comical ritual lead most people to be confident that the debt limit will be gotten around, but it also tells us that those running our political system lack discipline or they tacitly agree that binge borrowing is OK. I think it makes clear that the long-term prognosis is for the debt bingeing to go on until a crisis ends this dynamic. However, most people seem comforted that the debt limit won’t trigger a debt default and don’t worry about the debt bingeing continuing. That raises the justifiable questions: Is it a good or bad thing that we are getting around this debt limit? Are high debt levels and high levels of new borrowings that require high levels of government selling of debt assets not risky? I think those are reasonable questions as we have been hearing warnings of a debt Armageddon for decades yet none has occurred.
About three weeks ago I put out a report that was the first of a two-part examination of the mechanics of debt. The first part is about the money-credit-debt-market-economic mechanics and the cycles they create. It explains in simple terms how I believe the mechanics work. In it I describe how both the short-term and long-term cycles work, most importantly the interactions between borrower-debtors, lender-creditors, and central bankers, and the consequences these interactions have on markets and economies.
I think we need to talk about the mechanics of what has happened and what will determine where we are probably headed. Doing that before we express our views about what’s happening and what is likely to happen is essential. It’s nonsensical to talk about what is happening and what is likely to happen without first agreeing on how the mechanics work. We can’t possibly answer such basic and important questions as whether the government can continue to accumulate debt in large amounts without facing bad consequences, and if there are going to be bad consequences, what they will look like and what will bring them about, without first knowing how the mechanics work.
By the way, the mechanics are pretty simple because the finances of countries’ governments work the same as the finances of individuals and organizations, except governments have the abilities to 1) print money and 2) take money from some people and give it to others. How this works is particularly important now because the US government (and people) are deeply in debt and need to spend on many things such as taking care of those who don’t have enough to pay for the basics, like supports for children in poverty, education, infrastructure, defense, climate remediation initiatives, mental and physical health initiatives, supports for other countries, etc. Because money and debt are not limited, those who make the decisions on how much to spend on what don’t look at how much money they have to spend and then prioritize what they should spend it on. They instead decide how much they want to spend and then decide whether they will get it from taxes (which is hard because people fight to keep their money) or borrow it, and if they borrow it, they have to decide whether they sell it to lender-creditors who want it or sell it to central banks who print the money to buy it. What they do and why is critical to understand for those who set policies as well as for those who are affected by them, so I look forward to our continued exploration of how the machine works and what it is most likely to produce.
PS: In Part 2, which I’m working on now, I will give a quick review of how the mechanics described in Part 1 have played out from 1945 (the beginning of the US and US dollar world order) until now, and take a look into the future.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Random Tweets
No random tweets this week. Follow me @SBlumenthalCMG.
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Trade Signals: Improving Trend Evidence – Extreme Optimism and High Recession Probability Signal Caution
January 25, 2023
S&P 500 Index — 4,016
Markets move in cycles, and cycles will always exist. Trade Signals provides a weekly snapshot of current stock, bond, currency, and gold market trends. Trade Signals is a summary of technical indicators to help you identify where we sit in short-term, intermediate-term, and long-term cycles. We track important valuation metrics as they can help us assess the probability of future returns (when investment opportunity is best/least). Trade Signals also tracks investor sentiment indicators and economic and select recession watch indicators.
Stay on top of the current trends with “Trade Signals.”
Market Commentary
Gold continues to shine. Following is a look at the weekly MACD signal. Green arrows are buy signals. Red arrows are sell signals.
Stocks remain in a major downtrend. Although stocks have experienced a 10% counter-trend rally over the last three months, their major trend is still down. The red line in the next chart shows the downtrend that’s been in place since the 2022 market peak at 4,800. The S&P 500 needs to clear that resistance line in a decisive way to signal an important trend change to the upside.
It is important to note that the S&P 500 is trading above its 50-day moving average land 200-day moving average lines and that the 50-day line is about to cross above the 200-day line (the historically bullish golden cross).
There is no change in the intermediate-term trend.
Recession is a big economic risk. The Fed remains in tightening mode, the yield curve remains inverted and while inflation is improving, hoping for a Fed Pivot is a bit premature, in my view.
The Dashboard of Indicators follows next which includes the economic and select recession watch and gold indicators.
Click HERE to see the Dashboard of Indicators and all the updated charts in this week’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizons, and risk tolerances.
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Personal Note: Fly Eagles Fly
If you don’t have an NFL team to root for, send a little love to my Philadelphia Eagles. The Birds face the 49ers in the NFC Championship game on Sunday at 3 pm ET. With a trip to the Super Bowl on the line, it’s bound to be an exciting game.
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here. Follow me on Spotify, Twitter @SBlumenthalCMG, and LinkedIn.
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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