Connect with us

Economy

Will the Fed’s actions push the US into a recession?

Published

on

The Fed is credited for softening the blow of the last financial crisis and leading the economy on the path of recovery – albeit a slow one. However, citing historical precedence, analysts at MKM partners believe that the Fed’s action of reducing the size of its balance sheet might push the economy into a recession.

Important observations

  1. The current economic expansion is the third longest in history
  2. The present cycle, however, is one of the weakest since World War II on a few fronts
  3. Fed is planning to shrink its mammoth balance sheet
  4. Previous exercises to reduce balance sheets have ended up in a recession
  5. With a recession, more often than not, the equity markets enter into the bear territory
  6. While experts are divided on the next recession, it is worthwhile to be prepared for it

A talk of recession, especially after the strong second quarter growth of 2.6% might sound irrelevant, however, a few data points warn us to pay attention to them. Let’s understand them in-depth.

Third longest stretch of economic expansion

The US economy reached a milestone on July 28, of being recession free for the past eight years. The current recovery cycle is the third longest in the history. The largest recession free period lasted 120 months, from March 1991 to March 2001, followed by a 106-month long streak that ran from February 1961 to December 1969.

Nevertheless, the current recovery has been the weakest since World War II on fronts like pace of growth and wage gains.

The US GDP has grown a measly 19% in the last eight years. Relatively, in the same span, the GDP had grown 34% during the 1991-2001 expansion, whereas, the growth was much stronger in the 1961-1969 period when the GDP grew by 51%.

Though the jobs growth has been robust, at 12%, they lag the previous two expansions in the same time span. In the 1991-2001 period, jobs grew by 18%, while the job gain in the 1961-1969 period was a whopping 30%.

There is no direct comparison of wage growth – which has been a major eyesore during the ongoing recovery cycle – as the government did not collate data on hourly pay for private-sector workers until 2006. Notwithstanding, a study by the Economic Policy Institute shows that pay for the rank-and-file workers, adjusted for inflation rose a paltry 3.5% from 2009 to 2016, whereas, in 1991-1998, it had risen 6% and during 1961-1968 it had risen by an impressive 13.5%.

However, it is not all gloom and doom because it also has a few credible achievements to its name.

A few records created in the current recovery cycle are – job addition for 81 straight months, the longest streak ever and the number of citizens applying for first-time benefits has been below 300,000 for 125 consecutive weeks, the longest stretch since 1970.

Agreed that the current economic recovery has been weak, but the length and the weakness are no reason to suspect that it is about to end. Is there any reasonable data that points to a looming recession in the near future?

What happened when the Fed reduced its balance sheet on previous occasions

As a result of the quantitative easing programs during this economic cycle, the Fed’s balance sheet has ballooned to $4.5 trillion. Now, the Fed Chair has said that the economy is strong enough for it to consider shrinking its bond portfolio.

However, historical results of such an exercise have ended up with a recession most of the times.

According to a research by Michael Darda, chief economist and market strategist at MKM Partners, five of the six past balance sheet reductions – in 1921-1922, 1928-1930, 1937, 1941, 1948-1950 and 2000 – have ended up in a recession.

Not only that, the Fed’s tightening (rate hike) has also led to a recession 10 out of 13 times.

The Fed is likely to announce their plan in September. They are expected to let a specific size roll off every month and reinvest the rest. It is likely to be a slow roll off that will be raised quarterly until it reaches $50 billion a month. The Fed plans to continue the roll off until the balance sheet size shrinks down to $2 to $2.5 trillion. The whole process can take about four to five years, if it runs without any breaks in between. Though the Fed is confident that the slow process will be painless, the experts are not convinced.

“Against this historical portrait, a pressing question arises: will credit markets and equity volatility remain quiescent moving into the second half of next year when balance sheet reduction and rate hikes — a double-barreled tightening — begin to move along at full force?” Darda said, as reported by CNBC.

Peter Boockvar, chief market analyst at The Lindsey Group believes that historically, the tightening cycles have led to a recession and this time is not going to be any different. The communication from the Fed is not going to limit its impact.

Everyone doesn’t believe that a recession is around the corner

The S&P Global Ratings firm recently reduced the risk of a recession in the US from 20%-25% to 15%-20%. S&P believes that the economy will chug along slowly at a growth rate of 2.2% for the rest of this year and at 2.3% in 2018.

Economists at Goldman Sachs believe that there is two-thirds chance that the current economic expansion will exceed 120 months and become the longest recovery on record. They, however, believe that the risk for a medium-term recession is rising “mainly because the economy is at full employment and still growing above trend,” reports CNBC.

Be prepared, as the recession might be nasty for people who are not ready for it

Are we the only one fearing a recession? No.

In a recent Bloomberg survey, 25 finance professionals from four continents believed that the next US recession would start in the first half of 2019. Their main concern was the coordinated tightening by the central banks. The US Fed is expected to start winding down its balance sheet by the end of this year, and the European Central Bank and the Bank of Japan are also expected to commence tapering their asset purchases.

More often than not, recessions and bear markets go hand in hand, as can be seen in the chart below.

Though it is not necessary that the next bear market is as vicious as the last one, the past three bear markets have been more vicious than the preceding one, as seen in the chart below.

Therefore, traders should be prudent while committing new money into the stock market at the current levels. Also, the existing positions should be protected with suitable stop losses. Holding some cash in the portfolio is also a good option. After all, the smartest investor among all, Warren Buffet is currently holding on to a cash chest of $90 billion, as he is not finding good bargains at the current levels.

Hence, at the risk of some underperformance, why not join the legendary investor and be ready to buy stocks when there is a SALE in the near future.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

Rate this post:

Important for improving the service. Please add a comment in the comment field below explaining what you rated and why you gave it that rate. Failed Trade Recommendations should not be rated as that is considered a failure either way.
0 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 5 (0 votes, average: 0.00 out of 5)
You need to be a registered member to rate this.
Loading...

4.7 stars on average, based on 9 rated postsRakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.




Feedback or Requests?

Click to comment

You must be logged in to post a comment Login

Leave a Reply

Economy

Why The Dollar Will Get Stronger

Published

on

What a contrast.  Just taking a look back to the financial crisis now 10 years old.  Everything seemed bleak.  The stock market crashed to a Dow low of 6700, banks stopped lending money, residential real estate foreclosures hit new highs.  Major Wall Street investment banks like Bear Stearns and Lehman Brothers went out of existence.  The outlook was bleak.

Today we live in a very different world.  Technology jobs are going unfilled.  Housing prices last month rose 6.5% on an annual basis. The stock market is busting out to new high levels with the regularity of a Swiss watch.  The VIX Index which is suppose to measure investor fear is mired near a five year low.  GDP in the second half of 2017 pickup to just under 3%.

But then the is the issue of inflation and how it will impact Federal Reserve monetary policy under new chairman Jerome Powell. Conversely how will Fed Policy influence the foreign exchange markets.  Early signs point higher interest rates and means a strong dollar.

Is Inflation Heading Higher

It has indeed been a long time since anyone worried about inflation.  It was way back in the late 1970’s and since then the world has been on a slow glide path toward obliterating inflation.  For two years in 2015-2016 near zero change took place in overall price levels.

This occured in the face of the Fed injecting liquidity of as much as $80 billion a month into the US economy at the peak of the Quantitative Easing.  The stated purpose of the program was to avoid the real enemy, deflation by aiming monetary policy toward a sustainable 2% annual pace of price increases.

Last the Fed reached it target.  By last December a 2.11% inflation rate was achieved.  Quantitative easing is over and the Fed is now reworking it balance sheet by soaking up all that excess liquidity created over the previous years.  

So What Does This Mean

If you think that inflation is being minimized by organic forces in the economy like technology you would be quite right even though such impact has not been showing up in the overall US productivity.  

There are a few things that have yet to be conquered by technology: housing, healthcare and education. The website ValuePenguin calculates the the average family spends 43% of their gross income on these three areas.  We think this figure is low and for many families it is closer to 60%..

For the past two plus years housing costs have far outstripped the overall rate of inflation. In the top 10 cities for high paying jobs, the shortage of housing is forcing prices to levels often unaffordable.  This puts price pressure on labor rates for those big tech jobs.  So far technology has not created an App to make cheap land in Silicon Valley.  There is plenty of cheap housing in Detroit, but jobs are harder to find.

Based on expected levels of family formations, the housing shortage isn’t ending anytime soon.

Healthcare is another area that stubbornly resists even the most comprehensive efforts to control costs.  With the passage of the new tax bill in December, the Affordable Care Act is effectively being put in limbo by Congress.  The best guess is that healthcare inflation in 2018 and beyond will rise at a faster rate for the next several years.

ValuePenguin tabulates that education costs comprise just 2% of a family budget. This is only true if the family has an average of two small children in daycare.  If we include either private schools or the cost of college, this is a different picture.  The overriding point here is that education cost inflation is raging higher every year.

Price Stability Is Over

Is inflation headed for 4% or higher? Nobody has that answer.  However,  inflationary pressures have already started to mount and that is clear.  Under new Fed Chair Powell, all ears will be listening more closely than ever for chatter about FOMC meetings and post meeting interviews of Fed officials.

For the first time in many years, our money is going on several reactionary interest rate increases in 2018 and that spells good news for owners of US dollars.  

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

Rate this post:

Important for improving the service. Please add a comment in the comment field below explaining what you rated and why you gave it that rate. Failed Trade Recommendations should not be rated as that is considered a failure either way.
1 vote, average: 3.00 out of 51 vote, average: 3.00 out of 51 vote, average: 3.00 out of 51 vote, average: 3.00 out of 51 vote, average: 3.00 out of 5 (1 votes, average: 3.00 out of 5)
You need to be a registered member to rate this.
Loading...

4.4 stars on average, based on 97 rated postsJames Waggoner is a veteran Wall Street analyst and hedge fund manager who has spent the past few years researching the fintech possibilities of cryptocurrencies. He has a special passion for writing about the future of crypto.




Feedback or Requests?

Continue Reading

Economy

Tax Cuts and the US Stock Markets

Published

on

The stock markets rise or fall on sentiment, earnings, and economic data. While the initial boost following the US Presidential elections was sentiment driven, the markets held their own as the data flow stabilized and improved in the US and around the world. However, at the current levels, the US stock markets look pricey compared to historical averages.

Key points

  1. The markets are trading at rich valuations even after discounting a favorable tax cut
  2. Treasury Secretary Steven Mnuchin believes market will crash without a tax reform
  3. A few analysts believe that the markets will remain firm even without a tax cut
  4. We believe markets will be vulnerable for corrections if Republicans fail to pass the tax cuts
  5. Buy the rumor regarding tax cuts and sell once the news of a tax reform is announced

Nevertheless, the hopes of a tax reform have kept the markets buoyed. How much can these tax cuts add to the markets and what is the risk if the reforms are watered down or just don’t see the light of the day?

Analysts expectations for the S&P 500

The S&P 500 is expected to end 2017 with earnings of $131 per share, increasing about 10% over 2016. For 2018, analysts expect the S&P 500 companies to collectively earn $145.2 per share.

However, there are differing views on whether these figures include the benefits accrued from the tax cuts or not. If the tax benefits are incorporated, then to what extent.

The most bullish analyst on the street, Morgan Stanley’s chief U.S. equity strategist, Mike Wilson, believes that about $9 of $145.2 in the earnings projection is based on the benefits arising out of a tax cut. On the other hand, the most bearish analyst, Weeden & Co.’s Mike Purves, believes that $14 per share is from the tax cuts.

Let’s take a bullish scenario.

Analysts expect the annual per-share earnings to increase by $15 if the corporate taxes are cut from 35% to 20%.

However, Wilson has only accounted for $9 in benefits from the tax cuts. Therefore, we will have to add another $6, which gives us a figure of $151.2.

So, in the most bullish scenario, at 2580, the S&P 500 is trading at a forward p/e of 17 times.

Factset data shows that the 5-year average and 10-year average forward earnings P/E ratio of the S&P 500 is 15.6 and 14.1 respectively. Therefore, even with the most optimistic scenario of earnings built in, the S&P 500 is currently trading above its past averages.

However, just because its current valuations are above the historical averages will not cause a correction in the markets. But, can a failure to pass the tax cuts start a fall?

What if the tax cuts don’t see the light of the day or are diluted in their effect

Again, we shall consider the most bullish scenario. If the Republicans fail to pass the tax reforms, then the earnings projection for next year will fall by $9, to $136.2. At that level of earnings, the S&P 500 is currently trading at a P/E of $18.9, which starts to look pricey.

What level was the S&P 500 trading prior to the two previous crashes of 2000 and 2007?

As seen in the chart sourced from yardeni.com, the S&P 500 is already trading at a higher forward P/E than 2007. This confirms that we don’t have the comfort of valuations behind us. However, we are still a distance away from entering into a bubble territory when compared with the forward P/E of 24, recorded during the heights of the dotcom bubble. Therefore, a crash might not be in the offing.

How much will the S&P fall if the tax reforms don’t go through

Here again, there are two schools of thoughts. While one says that a failure to ring in the tax reforms can easily plunge the S&P 500, others believe that the stock market is unlikely to fall more than 5%.

Treasury Secretary Steven Mnuchin believes that a lot is riding on the tax reforms. In a podcast with Politico he said: “To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done, you’re going to see a reversal of a significant amount of these gains.”

However, Credit Suisse and Morgan Stanley differ, as they don’t see a market crash even if the tax reforms fail.

“The market rewarded firms with high effective tax rates for only three weeks post-election, but not since,” wrote Jonathan Golub, Credit Suisse’s chief U.S. equity strategist. “For that reason, we do not believe that stocks would be at risk if a deal isn’t struck,” reports CNBC.

In a note to its clients, Morgan Stanley has painted three different scenarios with no tax cuts, modest cuts, and substantial cuts.

Morgan Stanley believes that the markets will only fall by 1% if the tax cuts don’t happen.

What do we believe?

We believe that the US market rally in the past year has been driven by hopes of a fiscal boost and tax reforms. These have kept the sentiment positive. As a result, the markets have risen on favorable economic data in the US and around the world and has not given up ground even when the news was unfavorable.

However, after failing to repeal Obamacare, if the Republicans fail to push through a meaningful tax stimulus, the sentiment will be dented.

That will leave the markets vulnerable to sharp drops on any adverse news because the floor of the reforms and an earnings increase will be lost.

On the other hand, if the tax reforms are announced, the markets are certainly likely to surge in the short-term, however, the bump up is unlikely to last for more than a few weeks. Usually, experienced traders buy the rumor and sell the news. We expect the same to repeat once the reforms are announced.

The markets will correct and the focus will shift to the effects of the stimulus at this stage of the recovery, which has been questioned by many economists. The Federal Reserve may also have to tighten at a faster pace than expected, which may neutralize some of the effects of the rate cuts.

Bottom line – To buy or to sell?

Buy the rumor of a substantial tax cut. However, once the cuts are announced, please book profits in the ensuing buying stampede.

On the other hand, if the tax cuts fail to materialize, keep the buy list ready to enter on any fall, which is closer to 8% to 10%.

Featured image courtesy of Shutterstock. 

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

Rate this post:

Important for improving the service. Please add a comment in the comment field below explaining what you rated and why you gave it that rate. Failed Trade Recommendations should not be rated as that is considered a failure either way.
0 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 5 (0 votes, average: 0.00 out of 5)
You need to be a registered member to rate this.
Loading...

4.7 stars on average, based on 9 rated postsRakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.




Feedback or Requests?

Continue Reading

Economy

U.S. Nonfarm Payrolls Unexpectedly Decline in September

Published

on

The U.S. job machine slowed significantly in September, as Hurricanes Harvey and Irma ripped through the southern states, disrupting local economies in their wake.

Overall nonfarm employment fell by 33,000 last month, following a revised gain of 169,000 in August, the Department of Labor reported from Washington. Analysts in a Bloomberg survey forecast an increase of 100,000.

The jobless rate declined to 4.2% even as workforce participation rose. That’s a level not seen since 2001.

Signs of wage inflation were present last month. Average hourly earnings rose at a faster 0.5% on month and 2.9% annually, official data showed.

Earlier this week, payrolls processor ADP Inc. said U.S. private sector employers added 135,000 positions last month. Economists had projected 98,000.

Hurricane Harvey made landfall in Texas at the end of August, triggering the biggest weekly spike in jobless claims since 2012. A total of 298,000 Americans filed for state unemployment benefits in the week ended Sept. 2, a gain of 62,000 from the week before.

September was the first negative reading on payrolls in seven years. Hiring is expected to rebound in the fall as the states of Texas and Florida resume cleanup efforts in the wake of hurricane season.

Solid employment growth has been one of the few mainstays of the U.S. economic recovery, prompting the Federal Reserve to gradually normalize monetary policy. The Fed is widely expected to raise interest rates again before year’s end. The Fed’s “great unwind” of its balance sheet will begin this month at a rate of $10 billion.

The report had no immediate impact on the currency markets, with the U.S. dollar index (DXY) rising gradually shortly after the data were announced.

«Featured image from Shutterstock.»

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

Rate this post:

Important for improving the service. Please add a comment in the comment field below explaining what you rated and why you gave it that rate. Failed Trade Recommendations should not be rated as that is considered a failure either way.
0 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 50 votes, average: 0.00 out of 5 (0 votes, average: 0.00 out of 5)
You need to be a registered member to rate this.
Loading...

4.6 stars on average, based on 550 rated postsSam Bourgi is Chief Editor to Hacked.com, where he specializes in cryptocurrency, economics and the broader financial markets. Sam has nearly eight years of progressive experience as an analyst, writer and financial market commentator where he has contributed to the world's foremost newscasts.




Feedback or Requests?

Continue Reading

5 of 15 Seats Available

Learn more here.

Recent Comments

Recent Posts

A part of CCN

Hacked.com is Neutral and Unbiased

Hacked.com and its team members have pledged to reject any form of advertisement or sponsorships from 3rd parties. We will always be neutral and we strive towards a fully unbiased view on all topics. Whenever an author has a conflicting interest, that should be clearly stated in the post itself with a disclaimer. If you suspect that one of our team members are biased, please notify me immediately at jonas.borchgrevink(at)hacked.com.

Trending