David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.
Some economists are publishing work showing that the stock market has only accurately predicted half of the post-Second World War recessions, but this is a dubious assertion. Every single peak in the business cycle historically followed the peak in the market cycle by an average of six months. Our proprietary cyclical equity market composite fell 22 per cent from the peak and that alone spells a 67-per-cent chance of recession. The yield spread between the two- and five-year bonds inverted, and this too spells an 80-per-cent chance of recession. And what do you know, but 80 per cent of all Fed tightening cycles were followed by an economic recession. But the typical economist or strategist never seems to think that a recession will happen – even though we’ve incurred 10 of them since 1950. Denial will only take you so far.
On top of that, copper and steel are still in bear markets, down 20 per cent, and tell me that lumber isn’t braced for economic contraction, having plunged 50 per cent (!) from its nearby high. Fully 14 bellwether companies have either issued warnings or missed their quarterly sales/profit estimates in recent weeks. Macy’s, Kohl’s, L Brands did not have very good reports, and investors must be seeing something in Target’s outlook that took its share price down nearly 3 per cent on Thursday (even as the company posted decent sales figures). And that’s not to mention the air carriers, which slid yesterday on the trimmed profit guidance by American Airlines. This is a warning shot from the market that we cannot expect the U.S. consumer to carry the load again in 2019.
None of this means that this tradeable equity rally has to run out of steam. But it does mean this is a rally for traders to rent, and not for investors to own. The market had become woefully oversold at the Dec. 24 lows, and every time we have seen such a meltdown, a brief but sharp rally took hold. All the more so in the onset of a bull market — the best days ever for the S&P 500 took hold in 2002 and 2008. What is typical in a bear market rally is that the S&P 500 bounces 16 per cent from the nearby lows and in the process, reverses 75 per cent of the peak-to-trough decline. So on that basis, this rally can take the index to 2,700 and that does not change one thing from a fundamental basis. It leaves the peak at Sept. 20, and remember — peaks in the market always lead peaks in the economy.
We have to put this bounce-back in the context of the worst December since 1931. Think about that for a second: the worst December – a normally positive seasonal period of the year – since the depths of the Great Depression. This is not a depression we are talking about now, nor is it anything close to 2008/09. It is just the cycle at play — that’s it. And it’s what normally happens at this stage of the monetary policy cycle, too. Historians will be writing about how the Fed, as it has done on so many occasions, overtightened this time around (both the September and December rate hikes were overkill). We will find out that this view of the “neutral” funds rate being 2.75 pert cent was around 75 basis points too “rich.”
But back to the markets. Let’s go back to what happened after December, 1931. Even in the context of that truly horrible macro environment, the stock market settled down nicely for two months as the oversold technical condition got redressed (in fact, the S&P 500 rebounded nearly 20 pert cent from the oversold lows). But, within the ensuing four months, the major averages were down more than 40 per cent. Now this is not at all a “call” or forecast but rather an observation that what we are seeing today is likely not what we will be seeing a few months from now. Just as last year, by the end of October pretty well everyone forgot that the stock market began the year in January with its best start since 1987.