This Is Why We’re Heading for a Recession

RecessionThe stock market may not be 100% accurate when it comes to predicting a recession. After all, the markets go through predictable cycles. That said, the markets always tank when there is a recession. The big question is: are we heading for a recession? And if so, does it really even matter if we enter a recession? Does it make you feel any better to know the U.S. economy is grinding down and your retirement fund lost 20% of its value, but we’re not in a technical recession? Investors need to be objective and look for opportunities.

U.S. Recession Just Around the Corner?

The stock market, it is said, because it is forward-looking, is not good at predicting a recession. After all, the markets can be volatile and throw off false alarms. On top of that, so the story goes, a reversal of 10% or more during a bull market is not unusual. All of which, for the most part, is true. Markets cycle: boom, bust, echo.

So, yes, correlation is not causation. On one hand, a reversal does not predict a recession every single time. On the other, whenever there is a recession, the markets reverse. The question: are the current economic indicators pointing to a recession? Or, are the markets just swooning because investors are taking profits off the table?

Frankly, I don’t really know anyone who holds to the latter, other than those who manage funds or brokers who live for commissions. It’s one thing to pump a garbage penny stock, but it’s quite another to pump the untold riches and wonders of an economy in decline.

U.S. and global stocks are declining and entering bear market territory, not because everyone is taking profits. The markets are tanking because there’s no reason for them to be bullish.

I’m not saying investors should flee the village. Just be objective and look at the economic data that help fuel the stock market. And, if necessary, adjust your portfolio accordingly.

GDP Data Not Encouraging

When the markets are doing well, analysts point to strong gross domestic product (GDP) growth, strong manufacturing data, and strong earnings and revenues coming out of Wall Street, in addition to strong consumer confidence levels.

We are seeing none of that.

The world’s largest economy—one that gets more than 70% of its GDP from consumer spending—is not doing well. The holiday-rich fourth-quarter GDP came in at a paltry 0.7%. That’s significantly lower than the third-quarter GDP growth of two percent and much lower than the 3.9% reported in the second quarter. (Source: “Gross Domestic Product: Fourth Quarter and Annual 2015 (Advance Estimate),” Bureau of Economic Analysis, January 29, 2016.)

Manufacturing Data Not Encouraging

U.S. manufacturing data is not encouraging. The flash manufacturing purchasing mangers’ index fell to 51.0 in February from a reading of 52.4 in January. This matches the lowest level since September 2009. Ever-optimistic and accuracy-deprived economists were expecting a reading of 52.5. (Source: “Markit Flash U.S. Manufacturing PMI,” Markit Economics, February 22, 2016.)

And this wasn’t a one-off. Manufacturing output growth slowed in February for the third time in the past four months. At the same time, new business volumes increased marginally—and at one of the weakest rates in three years.

This echoes other manufacturing data coming from the Fed. The Richmond Manufacturing Index for February came in at negative four—a big disappointment for analysts who had forecast a reading of positive four. (Source: “Manufacturing Sector Activity Slowed,” Federal Reserve Bank of Richmond, February 23, 2016.)

The Philly Manufacturing Index fell for the sixth straight month in February, coming in at -2.8. (Source: “February 2016 Manufacturing Business Outlook Survey,” Federal Reserve Bank of Philadelphia, February 18, 2016.)

Fourth-Quarter Data Not Encouraging

The U.S. is not alone in its misery. The global markets are in bear market territory with the MSCI All Country World Index down more than 20% from last May. Specifically, Canada, China, France, Germany, Spain, Sweden, and Japan are all in bear market territory.

Of course, Russia is too, but that’s a given. A shirtless Vladimir Putin riding horseback can only do so much for the Russian economy.

The markets are only as strong as the stocks that make them. Too bad that isn’t encouraging. In addition to weak domestic growth, almost half of all S&P 500 companies get sales from outside the U.S. (Source: “Did S&P 500 Companies With Higher Global Exposure Report Lower Earnings Growth in Q4?” FactSet, February 19, 2016.)

In fact, those S&P 500 companies with more global exposure report weaker sales and earnings growth when compared to those S&P 500 companies with less global exposure.

S&P 500 companies that generate more than 50% of sales inside the U.S. reported fourth-quarter blended earnings growth of 2.7%. Those that generated less than 50% of sales inside the U.S. reported a blended earnings decline of -11.2%.

Blended sales decline for companies that derive more than 50% of sales from inside the U.S. was a miserly 0.8%. Companies that generate less than 50% of sales inside the U.S. chalked up a blended sales decline of -13.0%.

Overall, the blended fourth-quarter earnings decline for the S&P 500 is -3.6%. The blended sales decline for S&P 500 companies in the fourth quarter is -3.7%.

But fear not—spring is just around the corner. Economists are telling us things will pick up then.

Consumer Sentiment Not Encouraging

Weak fourth-quarter earnings results and global economic downgrades from the Organisation of Economic Co-Operation and Development (OECD), the World Bank, and the International Monetary Fund (IMF) suggest more misery is on the way. But American consumers already know that.

Consumer confidence tanked in February to its lowest level in seven months. For some odd reason, Americans are disregarding what their brokers are telling them and have become pessimistic about job prospects, the overall U.S. economy, and big losses on the stock market. (Source: “The Conference Board Consumer Confidence Index Declined in February,” The Conference Board, February 23, 2016.)

What investors did not say is that they are beaming with optimism and were taking profits off the table because they needed some extra cash for a trip.

The consumer confidence index fell to 92.2 from a revised 97.8 in January. Economists were forecasting a slight decline to 96.9. Somehow, those in finance seem to be out of step with what the average American is thinking and feeling.

One astute, sympathetic economist even said, “Apparently the consumer is not immune to all these nervous financial market headlines.” He goes on to say that he hopes consumers don’t lose hope because they drive the U.S. economy. (Source: “Consumer confidence falls to 92.2 in February,” Times Colonist, February 23, 2016.)

That’s embarrassing.

This does not mean the U.S. is 100% heading for a recession. But who cares? The markets are down and there’s no impetus right now to drive them higher.

Translation: If you’re a buy-and-hold investor, you don’t care. But if you aren’t (or you’re one of the many buy-and-hold investors who can’t stomach it when the markets are in free-fall), the outlook isn’t very encouraging.

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