The easy-money era is over! Now, recession redux is upon us. It may seem early because it still feels like we are coming out of the last one. But a 50% stock tumble is not out of the question, and by the time you realize what’s happening, it might be too late to protect your portfolio.
America is in the midst of the sixth-longest expansion since the Civil War, and we haven’t had a meaningful equities correction in nearly 5 years. The Federal Reserve, citing significant improvements in the labor market, tells us it’s time to normalize monetary policy. But we look around and see that, for most Americans, there is no boom and incomes have barely budged, putting a lid on consumer spending — which makes up more that 70% of the U.S. economy.
The fact is: The vast stock market wealth of the past seven years has been created by ultra-cheap credit — and that party ended when the Fed stopped buying $3 trillion of financial assets. As the Fed begins dumping its inventory on the market, the banks will have to absorb some of that flow, meaning they won’t have the capital to speculate in stocks. That will create a massive overhang that will cause equities to crash and plunge the U.S. economy into yet another recession.
The danger signs are already flashing. Jonathan Johnson, the CEO of Overstock.com, may have had the right idea when he bought $10 million in gold coins to meet payrolls and three months of food for his employees. Corporate profits have peaked, stock buybacks have peaked and yield-chasing has peaked. But the most telling signals come from the junk bond market. Junk bond yields are like the canary in the coal mine of financial markets — they always warn first. Note how junk bond yields (blue line in the chart below) tend to rise before recession hits (grey area) and business investments turn negative (green line). According to the chart, these signs are appearing once again, but what is dangerous about today versus the past two downturns is that the Fed has no leeway to lower rates. Instead they are foolishly raising interest rates, which could make things much worse.
One of the main consequences of higher U.S. rates is a strong dollar, which may sound great if you’re headed to Paris to pick up a few Louis Vuitton bags, but it’s actually a serious problem for the U.S. economy. We’ve already seen scores of Fortune 500 companies cry foul as they blame their subpar earnings on the dollar. As the greenback rises further, the downward pressure on profits will only become stronger, heightening risk of a meltdown in stocks and ushering in a new recession.
In that case, why is the Federal Reserve raising rates? Their excuse is to control inflation that has yet to appear, but in reality it is only raising interest rates so they can be lowered again when recession returns.
|“The Fed is foolishly raising interest rates, which could make things much worse.”|
Even Bridgewater, the world’s largest hedge fund, is worried. They released this note just before the first rate hike, warning of a repeat of 1937:
“The first tightening in August 1936 did not hurt stock prices or the economy, as is typical. The economy remained strong going into early 1937. The stock market was still rising, industrial production remained strong, and inflation had ticked up to around 5%. The second tightening came in March of 1937 and the third one came in May. While neither the Fed nor the Treasury anticipated that the increase in required reserves combined with the sterilization program would push rates higher, the tighter money and reduced liquidity led to a sell-off in bonds, a rise in the short rate, and a sell-off in stocks. Following the second increase in reserves in March 1937, both the short-term rate and the bond yield spiked.
Stocks also fell that month nearly 10%. They bottomed a year later, in March of 1938, declining more than 50%!”
In other words, the Fed’s exit strategy in 1937 was a big disaster.
Why are we comparing the current economic cycle to 1937? Because the Federal Reserve used the same tools to fight the Great Depression as it did to fight the 2008 Global Financial Crisis — zero interest rates and balance-sheet expansion and it was duped into raising interest rates prematurely by a modest recovery.
We are already beginning to see signs of a top in stocks, but keep watching junk bond yields. If they exceed the 2003 peak — be prepared for trouble.
All gloom and doom? Well, not totally — there are ways to protect your portfolio and profit from the unnerving uncertainty and volatility in the financial markets. We will have more columns this week to discuss the issues and opportunities facing us, both in the U.S. and abroad.
Boris and Kathy
P.S. TIME’S ALMOST UP! Today is your last chance to read a report detailing a slam-dunk opportunity in the energy sector for you to potentially make triple-digit gains in a matter of weeks — and in some cases, a realistic shot at making 10 times your money over the next several years.
It’s simple: This WIPEOUT of the oil and energy industry — what Mike Larson is calling The Oil & Energy Fire Sale of the Century — represents your single biggest investment opportunity in ages!
But this report — and all the information on how to profit from decimated oil prices — goes offline at Midnight Eastern Time.
Click this link now … before this information is gone forever.