Let us repeat: Financial crashes cause recessions, not vice versa. So if you are waiting for NBER (National Bureau of Economic Research) or even some unusually enlightened Wall Street economist to call recession before exiting the casino, well, get prepared for some very bad hair days.
The old fashioned sequence of causation, of course, was that stock markets don't crash until they are triggered by warning signs, or the actual onset, of recession. But there is no mystery as to why that model has become inoperative.
To wit, the economic world today is dominated by a central bank driven regime we call Bubble Finance. Unlike during your grandfather's industrial era heyday circa 1960, the main street economy today is not the master and consumer of finance; it is its feeding ground and victim.
Accordingly, the Fed and other central banks foster serial bubbles; the latter are the inherent product of monetary central planning.
That's because today's central banks unleash massive and intensifying waves of speculation by means of ZIRP and QE. The former is the speculator's best friend because it deeply subsidizes carry trades funded on the front end of the curve.
For example, that's what Bear Stearns and Lehman were doing----until, of a sudden, they couldn't roll their overnight liabilities. They were then forced to dump their longer-dated, riskier and stickier assets---good ones and toxic ones alike---at fire sale prices.
At the same time, QE deflates bond yields and inflates PEs, thereby touching off a scramble for yield among fund managers and a financial engineering driven plunder of balance sheets and cash flows by stock option obsessed corporate C-suites.
At length, bubbles reach the financial stratosphere and burst under their own weight---sometimes on the seemingly slightest provocation.
One such trigger occurs when Keynesian central bankers finally loose their nerve (like at present) and seek to throttle their own blatant monetary excesses. But they cannot forward-guide a bubble-bloated market into a soft landing. So-called "tightening" cycles inexorably end up hammering confidence in the casino.
At the same time, bubble-ridden financial markets become increasingly vulnerable to unexpected shocks, like the sudden drastic collapse of securitized subprime mortgage paper in 2007. These shocks, in turn, trigger contagious waves of liquidation across the whole rotten structure of Bubble Finance.
Moreover, the Bubble Finance regime has also fostered a direct and potent transmission channel to main street recession, which comes into play almost instantly on the heels of a financial crash.
To wit, in the face of collapsing share prices and vaporizing stock options, the C-suites of corporate America have now been house-trained to attempt to appease the angry trading gods of Wall Street via economic sacrifices and propitiations called "restructuring plans".
Needless to say, that means drastic downsizing actions aimed at raising pro forma accounting and ex-items earnings----even as they generate massive charges for severance, inventory liquidations, factory, store and other facility closures and write-downs of goodwill and other intangible assets acquired during boom time M&A sprees.
What takes it on the chin, of course, is jobs, inventories, CapEx, R&D investment and other long-term investment spending chargeable to the income statement under GAAP accounting. In some measure, the liquidation of these items represents the traditional function of recessions---that is, purging excesses build up during the preceding, unsustainable boom.
But under the present regime of Bubble Finance, it is the crash of financial asset prices on Wall Street that triggers these purges, not the tightening of credit on main street which characterized the traditional sequence.
Moreover, the fury with which C-suite born recessions are instigated by the dynamics of Bubble Finance means that the main street purges are materially over done. Particular on the labor and inventory fronts, massive lay-offs and liquidations invariably trigger short-term rebounds in company stock prices, thereby encouraging the C-suites to err on the side of excessive cutbacks.
Of course, the re-hiring and re-stocking of the same during the next phase of recovery is one reason why monetary central planning looks so successful during the expansion phase. In essence, the Fed gets praised for capitalism's inherent tendency to expand, and for the decisions of businessmen to rebuild there operations after Fed-enabled bubbles crash and, at length, disappear into the rearview mirror.
The central roll of financial crashes in triggering and deepening recessions was starkly evident during the Great Recession. According to the mavens at the NBER it technically incepted in December 2007.
But as is evident in the chart below, it was the post-Lehman meltdown after September 15, 2008 that turned a mild slowdown into the great recession. The violence of inventory and labor liquidations shown in the chart clearly happened after September, and clearly reflect the panicked embrace of restructuring plans that swept the C-suites of corporate America.
For instance, business inventories were still rising versus prior year until early fall 2008, and the deep 400,000+ per month layoffs didn't commence until September.
If financial crashes trigger recessions, of course, you can't see them coming by reading the mainstreet entrails or looking for telltale recession warnings in the infamous "incoming data" from the Washington statistical mills. The latter are especially unreliable because they are trend-cycle adjusted----meaning they overstate activity levels substantially at turning points when downturns incept.
During the 12 quarters through Q2 of 2000, for example, real GDP growth had chugged along at the robust rates shown below. During that three year period the NASDAQ 100 rose by 245% and the S&P 500 by 65%.
Needless to say, there was nary a sign in the main street data that warned of a recession and, therefore, that the casino was fixing to plunge.
But it was. Twelve months latter the NASDAQ 100 was down by 60% on its way to an eventual drop of 75%.
Likewise, the S&P 500 big cap index was down 20% by Q2 2001 and ultimately by 45%. Nor can there be any doubt that it was the violently collapsing dotcom and tech bubbles which triggered the recession incepting in March 2001.
The story is essentially the same in the run-up to the financial crisis and Great Recession. Even after the subprime fissures broke out in the spring and summer of 2007 and the stock market stalled at its new peak of 1550 in October and November, the incoming data appeared solid, as shown below.
Indeed, the stock peddlers declared that it was an age of goldilocks, and that because there was no risk of recession, the market had only one way to go--up. Thus, the street consensus estimate at year-end 2007 was for a 17% gain on the S&P 500 to 1825 by December 2008.
Alas, the index actually came in 40% lower at 1050, and was on its way to at blow-out bottom of 670 ny March 2009.
To be sure, the Wall Street hockey sticks were right in the end. That is, the market did hit 1825---except is was six years later in March 2014!
Needless to say, here we are again-----with the talking heads repeating in unison: No recession, no worry.
In that context, a purported financial guru by the name of Robert Johnson recently took us to task for warning that the next crash "will be a doozy".
Now it so happens that Mr. Johnson's latest research publication was entitled "Invest with the Fed".
So make of that what you will, but his thesis well captures the current Wall Street mantra that the US economy is stronger than an ox. So don't sweat the small stuff or worry about another crash because there is no recession in sight.
The fact that we have been in an expansive economic mode for so long leads many to conclude that we are overdue for an economic downturn. However, the underlying data simply don’t support that conclusion..... the Conference Board forecasts growth at 2.8 percent for 2018 and 3.0 percent in 2019. Alternative measures of consumer and business confidence remain near 10-year highs. A greater percentage of Americans are working than at any time in this century, as the unemployment rate recently dipped below 4 percent for the first time since 2000.
The outlook for corporate profitability is the strongest we have witnessed in years.
In other words, a recession does not appear imminent.
That's right, and it doesn't matter. Contrary to the quoted passage above, the signs of recession under the regime of Bubble Finance do not lurk in real GDP deltas, consumer and business confidence indices, the unemployment rate or even short-term trends in corporate profits.
Thus, here is the same trailing 12 quarter trend of real GDP growth. Not surprisingly,the pattern is virtually indistinguishable (albeit at lower rates of gain) from the pre-2000 and pre-2008 sequence shown above.
Needless to say, the true warning indicators of an upcoming crash lie in the rot that has accumulated on Wall Street, not the short-run metrics arising from main street.
After all, if you can't see that the two have been radically decoupled, then you are not paying attention, as they say.
Thus, the NASDAQ composite index is now up 145% since the pre-crisis peak in November 2007, and by 120% in real terms when deflated by the CPI.
By contrast, total business sector output has expanded by just 18%, labor hours by 6%, median real household incomes by 2% and manufacturing output by negative 3%.
Stated differently, the stock market has not ridden higher on the back of a robust recovery on main street. And that's especially the case because the starting point at November 2007 pivots off a stock index that was already vastly inflated, as indicated by its subsequent 55% correction, which makes the decoupling shown below all the more egregious.
Instead, financial asset prices are hanging from a sky-hook---the product of another extended cycle of Bubble Finance. And as we indicated in Part 2, the Debtberg generated by monetary central planning lies at the heart of the present bubble.
As indicated above, the central evil of monetary central planning is that it deliberately falsifies financial asset prices and thereby causes money mangers, traders and speculators to make erroneous and often reckless decisions. And one especially blatant example of that is the so-called "search for yield".
It results in hidden time bombs across the length and breadth of the financial system as managers and speculators become increasingly desperate to meet benchmarks in the face of deep and sustain central bank suppression of yields.
Last summer for instance, New York underwriters sold $750 million of 100-year Argentine bonds at a yield of 7.75%. Notwithstanding that Argentina is a serial defaulter---7 times in the last century---and had defaulted again as recently as 2001, the issue was three times over-subscribed.
Needless to say, Argentina is already in the midst of its Nth financial crisis, and it central bank has been forced to raise interest rates to a punishing 40%. Last summer's century bonds have already sold-off badly, and the carnage has just begun.
In Part 3, we will amplify where the hidden time-bombs are lurking, but here's one of them. When the yield shock hits the bond pits and the benchmark UST passes through 4.0%, there is going to be a day of reckoning for EM issuers of dollar bonds, mostly junk.
Needless to say, when Humpty-Dumpty falls off the maturity wall, it's going to take more than the kings men at the central banks to put him back together again.
Consider 2000...no recession in sight.....2007-08 goldilocks........quote no recession in sight guy