Market Analysis: The Coming Recession

2022年7月23日

In this post, I will present a market analysis with a focus on recession metrics and indicators. Right now, many of them are sending a recession warning.

Home Prices -

U.S. home prices are surging higher at the fastest quarterly rate of change on record. (See chart below)



This extreme rate of change in home prices is occurring as U.S. 30-year fixed mortgage rates also explode higher at nearly the fastest quarterly rate of change on record. (See chart below)



Additionally, we see in the chart below that 30-year fixed mortgage rates have potentially broken out into a new uptrend on the longer timeframes. The best way to detect trend reversals is by using the Ichimoku Cloud. When the price closes above or below the cloud (the shaded area) it is considered to have "pierced" the cloud. Once the cloud is pierced to the upside, resistance becomes support. In this case, assuming the piercing sustains, we can see a sustained period of higher interest rates on 30-year fixed mortgages.



Exploding home prices and exploding mortgage rates occurring simultaneously is unsustainable. Examine the yearly chart of U.S. home prices below and notice the similarities between 2005 and 2022. Notice that the Stochastic RSI is extended to the upside, and that home price extends above the upper Bollinger Band. Looking at this chart one could reasonably conclude that in the coming years home prices are likely to revert to the mean (orange line), as they did during the Great Recession.



Many analysts try to contradict what this chart is suggesting by claiming that we are in much better shape now than during the sub-prime mortgage crisis prior to the Great Recession. But are we really? With spiraling inflation, every mortgage holder suddenly becomes relatively more sub-prime. We also did not see mortgage rates explode then as quickly as they are now.

Unemployment -

Analysts point out that the current low unemployment is a reason to believe a recession can be averted. But under the surface, that's beginning to change in a hurry. Below is a chart of most leading unemployment data published by the Federal Reserve: Seasonally Adjusted Initial Claims (Weekly).



In this chart, we see that in about a period of the past 4 months, the amount of new unemployment claims has risen by around 100,000 or about a 50% increase. Compare this to the chart from the 2007-2008, when the U.S. economy was beginning to enter a recession (the shaded area represents where the recession began):



In the period leading up to the Great Recession, we saw a rise of about 50,000 new unemployment claims or about a 15% increase over a similar 4-month period. Therefore, the rate of increase of initial unemployment claims (both in real numbers as a percentage) is higher now than when we entered the Great Recession.

Perhaps more worrisome is the difference in how accommodative the Federal Reserve was in response to rising unemployment. Here is how the Fed Funds Rate changed as unemployment began to rise in late 2007 into 2008:



As unemployment was rising, the Federal Reserve began to cut interest rates. Compare this to the current situation in the below chart which shows the Federal Reserve raising interest while unemployment is rising. This change in context is reflective of both the fact that the Federal Reserve is behind the curve with containing inflation and the fact that the Federal Reserve is prioritizing the current problem (inflation) at the expense of the future problem (unemployment).



We are experiencing a macroeconomic situation whereby rapidly rising initial unemployment claims are being paired with rapidly rising interest rates. This combination is unlikely to end with any other outcome than a recession.

For more details on unemployment data see here: dol.gov/ui/data.pdf
To interact with the initial unemployment claims data on a weekly basis you can go here: fred.stlouisfed.org/series/ICSA

Yield Curve Inversion -

The 10-year minus the 2-year Treasury yield is used to detect an impending recession. When the 2-year yield rises above the 10-year yield that creates a yield curve inversion, which can often indicate that a recession is coming. Right now the yield curve inversion is very steep. In fact, just recently, the yield curve inversion actually steepened to a level that was even worse than what we saw before the Great Recession.



Perhaps most alarming are the rates of change in interest rates. Look at the 10-year yield Rate of Change on a 3-month basis:



Here's the 2-year yield rate of change:



The federal reserve uses the 10-year minus the 3-month as a more reliable indicator for detecting an impending recession than the 10-year minus the 2-year. However, the rate of change for the 10-year yield has been so parabolic to the upside that the 3-month yield has been struggling to invert relative to it. However, that may soon change. Here's the 10-year minus the 3-month yield chart:



Volatility -

As you know, volatility is measured by the VIX. The yearly Stochastic RSI for the VIX is trending upward, signally the potential for greater volatility now and throughout the years ahead.



This part is a little confusing, but try to follow if you can: Volatility of volatility is measured by the VVIX and is considered a leading indicator of the VIX. Currently, the VVIX is so suppressed to downside that the K value of the Stochastic RSI oscilator has reached zero for only the second time ever. (The first and only other time this has happened was in 2008). While this may be more coincidental than predictive, it nonetheless suggests that volatility of volatility has nowhere to go but up. See below.



Margin -

Margin has already unwinded both in real numbers and as a percentage by a magnitude that is consistent with, and usually only occurs during, a recession. See chart below.



Credit to Yardeni Research, Inc. You can view their full report here: yardeni.com/pub/stmkteqmardebt.pdf

Stock Market -

Several bellwethers in the stock market are showing that, while we may have a robust rebound from extremely oversold levels in the short term, the longer timeframes look quite bearish, especially for the interest rate-sensitive tech and growth sectors.

For more details, here is my analysis on the QQQ/SPY relative performance:

Tech and growth are not alone in the bearish context. Indeed, the bull run from the end of the Great Recession to the current period has been characterized by increasing prices but decreasing volume. This is generally bearish, and may reflect that quantitative easing was a large cause of the bull run. Now, quantitative easing is ending in the face of spiraling inflation.



Other Metrics -

There are many other metrics that are used to detect recessions (e.g. GDP, PMI, M2V). Some may even look toward shifts in demographic trends, rising geopolitical tensions, declining globalization and climate change as recessionary factors. While I cannot discuss every possible metric, one last metric worth considering is the corporate bond market.

In 2020, during the COVID-19 shutdown, in order to stabilize markets, the Federal Reserve rushed in to save corporate bonds from crashing fearing that high borrowing costs for corporations could cause liquidity issues. Corporate liquidity issues can cause a whole host of issues from bankruptcies to layoffs. Currently, however, corporate bond prices have fallen to nearly that of the COVID low when the Federal Reserve rushed in to buy, yet the Federal Reserve is only just beginning quantitative tightening and just now beginning to roll bonds off its balance sheet.



Finally, I will leave you with this note: The time-tested winning strategy is to continue contributing as much as possible to your retirement fund. If the stock market crashes, do not stop or lower your contributions or try to pull money out because you think the world will end. Rather, continue to contribute as much as you can afford no matter what to a retirement mutual fund with diversified holdings. Contributions during market downturns will buy you more shares of your retirement mutual fund relative to the number of shares your contributions bought prior to the market crash. When price rebounds (and it will) you would have been glad to stick to this investment strategy.

2022年7月26日

注释

The recession that many Americans fear is coming is not "at all imminent".

Janet Yellen, Treasury Secretary
(June 19, 2022)

2022年12月30日

注释

As we head into 2023, I thought I would update this post from July 2022.

It is my conviction that we are now in the early phase of the recession. This recession will likely be characterized by severe stagflation. Stagflation is when GDP growth slows and unemployment rises, while inflation nonetheless remains high.

Despite the cooling demand that follows rising unemployment, inflation is likely to remain high due to ongoing commodity scarcities. In a world facing geopolitical conflict, deglobalization, climate change, and the ongoing pandemic, commodities remain scarce.

The below chart shows the current spread between the average 30-year U.S. mortgage rate and 30-year U.S. Treasury bonds. The current spread recently declined from an all-time high. This is a warning that a housing recession is not just coming, but has likely already begun.



Historically, every time the average 30-year mortgage rate exceeds the yield on 30-year Treasury bonds by more than 2%, a recession follows. The wide spread in rates shown in the chart above reflects the market's concern that the housing market is at risk of collapsing. When the market is concerned about the risk of an asset, it demands a higher return to invest in it. This means that the market is currently more concerned about the risks of investing in mortgage securities than it has ever been before.

The U.S. is currently experiencing the fastest and longest-lasting destruction of the money supply we've ever seen, with three quarters of declining M2 - an unprecedented duration. See the chart below.



As you look at this chart of a declining money supply, remember that U.S. companies can only ever earn a subset of the total supply of money. So if the money supply is falling at the fastest rate in history, and for the longest duration in history as well, what lagging effect might this have on future corporate earnings?

Of course, the U.S. money supply is used not just in the U.S., but as the world's main reserve currency it is used for debts and transactions globally. In a highly leveraged global economy, the Fed's rapid tightening is likely to cause a liquidity crisis, one that begins along the speculative fringes of the market and that reverberates inward. Already we are seeing a liquidity crisis spreading in the cryptocurrency market.

The Bank for International Settlements (BIS), often thought of as the central bank of central banks, recently published a warning that forebodes a coming global liquidity crisis. If the Federal Reserve continues to tighten or maintains existing tightened conditions at a degree tighter than the central banks of countries with lesser demanded currencies (e.g. Euro, Yen), FX swaps and forwards could become unstable.

Link to website: bis.org/publ/qtrpdf/r_qt2212h.htm

In my post below, I explain why I believe the worst is yet to come for the S&P 500.

The S&P 500's value is actually near a record high when compared to the risk-free rate (U.S. Treasury yields). Thus, it remains highly likely that due to much higher Treasury yields, and a confluence of other macroeconomic factors, capital will continue to flow out of the S&P 500, and into higher-yielding and less risky government bonds. In a worst-case scenario, whereby even government bonds become unstable, according to Exter's Pyramid, market participants could also rush to hold physical cash or physical gold, (and depending on how conditions unfold, possibly rush to hold Bitcoin in cold storage).



Yet, despite this extremely bearish outlook, not all hope is lost. First, markets tend to surprise us, and often, things do not unfold quite as badly as anticipated.
Second, the rules of good trading and good investing not only still apply to periods of crisis, but following them and remaining calm despite tremendous fear and uncertainty, can result in lucrative returns in the long term. No matter how far the stock market falls, it will still remain one of the most efficient means of wealth preservation over the long term.

Although Bitcoin and companies that develop blockchain technology have already been severely impacted by the growing liquidity crisis, Bitcoin will likely bottom in 2023 and then resume its march upward, and blockchain technology adoption will likely proliferate in the years and decades to come.

Although things may appear hopeless due to the seemingly insurmountable issues we currently face (conflict, pandemic, population decline, climate change, etc.) we will ultimately overcome each of these challenges.

In the years and decades ahead, human civilization will experience a technology boom as artificial intelligence and quantum computing exponentially increase productivity. We will see the development of sustainable energy including solar, wind, geothermal, hydrogen, and nuclear power which will make our energy resources cheaper, more efficient, more stable, and virtually limitless. We will go on to explore the deep recesses of our solar system and beyond. We will develop and expand 5G and 6G IoT technologies that will make communication virtually instant and which will pave the road for humans to work, interact and exist in augmented reality spaces, freeing us from the confinements of computers, televisions and cell phones.

No matter how bad the past year has been, or how bad the next will be, always remember that no amount of money can ever buy happiness.

I wish everyone a happy new year! 🥳 🎉

2023年1月13日

注释

Look what decades of virtually limitless monetary easing have done. Central banks should have never gotten into the business of negative interest rates (or paying banks to lend out money). Even early human civilization in ancient Babylon knew better than to set interest rates below zero.

This is a chart of the Rate of Change, or ROC, of the effective Fed Funds Rate over time.



We've never seen such a meteoric rise in these rates. Remember that the Fed Funds Rate is merely the cost of money, specifically the U.S. dollar. So what you're really looking at here is the meteoric rise in the rate at which the cost of a U.S. dollar is rising.

There's not much good that will come of this. There is likely no pathway by which the U.S. dollar's cost can rise this drastically and not cause liquidity issues in the highly leveraged global economy. All plausible outcomes involve some degree of economic recession. My research indicates that the recession has already begun. I hope to post more soon about the recession we're likely already in.

2023年1月28日

注释

For those who have asked for me to update this post, here's my latest long-term analysis:

2023年4月9日

注释

Since I published this post last summer, single-family home prices in the U.S. have come down substantially.

Yet, it's possible that the decline is not over. Price could remain weak until it finds support on its EMA ribbon.



The worst of a recession always comes right around the time unemployment peaks, but we're still at historically low unemployment. Eventually, this will change. Continuing jobless claims are bull flagging on the weekly timeframe at the same time that commodity prices are bull flagging on the monthly timeframe, as shown below.



This will likely result in stagflation. The coming recession will be characterized by rising unemployment and high commodity price inflation. In turn, this could result in prolonged headwinds for home prices, as persistently high mortgage rates and rising unemployment will make homes persistently unaffordable.

While many praise the fact that so many homeowners were able to buy or refinance a home at record-low interest rates, the result is inflation. The money consumers saved through lower mortgage interest payments has been diverted into scarce goods, driving their prices higher over time. In an economy, there is never a free lunch. What homeowners saved by securing a low interest rate mortgage, they will lose through the erosion of inflation.

This is the nature of the fiat-based financial system.

2023年4月25日

注释

This is likely the start of monetary policy whipsaw.