Is the Possibility of a Recession Increasing?

From Bloomberg:

The pain from higher borrowing costs may be spreading as consumers and businesses follow investors in shying away from risk, increasing the odds of a recession.

``While there is no basis for predicting a recession right now, the risks have surely gone up,'' says former Treasury Secretary Lawrence Summers, now a professor at Harvard University in Cambridge, Massachusetts. ``The combination of softness in the housing sector, contractions in credit, increased uncertainty and volatility, and losses in wealth make the chances significantly greater now.''

Economists at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. are among those lowering economic forecasts as the rising cost of credit prolongs the worst housing recession in 16 years. Now, two areas of the economy that have held up well so far, jobs and consumer spending, no longer appear immune to the fallout.

This prediction has been making the rounds on the internet.

Because of the problems in the credit market, many economists have lowered their overall predictions for economic growth. This shouldn't surprise anyone.

In addition, the two emboldened areas above have shown some weakness.

Here's a chart of personal consumption expenditures. The chart uses seasonally-adjusted annual rates in chained 2000 dollars. Notice we don't have a nice consistently upward sloping pattern. Instead, spending appears to have slowed over February to June of 2007. During this period gasoline prices were abnormally high. While gas prices have decreased since then, the consumer has faced two other issues that would crimp spending: a drop in stock prices which lower household net worth and the continued-fallout from the housing slowdown. Both of these have negatively impacted consumer confidence. Finally, the BEA lowered personal consumption expenditures to 1.4% growth in the latest GDP report. In summation, consumer spending as represented by the PCE expenditures from the BEA is an area of concern going forward.



Employment is a second area of concern. There are three areas to keep an eye on.

Construction Employment

Here is a chart from the BEA which shows construction employment since January 2001. Despite the drop in residential construction construction employment has barely dropped. There are two probable reasons for this.

1.) Non-residential construction has increased over the last year, absorbing lost residential jobs.

2.) Illegal labor's role in the construction area.



Financial services employment has shown continued advances over the last year. However, mortgage market problems started at the end of last year and show no sign of stopping. I wouldn't expect this employment sector to maintain the growth it has shown.



With the slowdown in consumer spending, retail employment has been stagnant for the last few months. A continued slowdown in consumer spending would obviously negatively impact this area of employment.



The short version is none of these areas is at a recessionary level yet. But both areas are clearly slowing in their rate of overall growth. In other words, we need to keep an eye on these levels going forward.

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Is the Possibility of a Recession Increasing?

From Bloomberg:

The pain from higher borrowing costs may be spreading as consumers and businesses follow investors in shying away from risk, increasing the odds of a recession.

``While there is no basis for predicting a recession right now, the risks have surely gone up,'' says former Treasury Secretary Lawrence Summers, now a professor at Harvard University in Cambridge, Massachusetts. ``The combination of softness in the housing sector, contractions in credit, increased uncertainty and volatility, and losses in wealth make the chances significantly greater now.''

Economists at JPMorgan Chase & Co., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. are among those lowering economic forecasts as the rising cost of credit prolongs the worst housing recession in 16 years. Now, two areas of the economy that have held up well so far, jobs and consumer spending, no longer appear immune to the fallout.

This prediction has been making the rounds on the internet.

Because of the problems in the credit market, many economists have lowered their overall predictions for economic growth. This shouldn't surprise anyone.

In addition, the two emboldened areas above have shown some weakness.

Here's a chart of personal consumption expenditures. The chart uses seasonally-adjusted annual rates in chained 2000 dollars. Notice we don't have a nice consistently upward sloping pattern. Instead, spending appears to have slowed over February to June of 2007. During this period gasoline prices were abnormally high. While gas prices have decreased since then, the consumer has faced two other issues that would crimp spending: a drop in stock prices which lower household net worth and the continued-fallout from the housing slowdown. Both of these have negatively impacted consumer confidence. Finally, the BEA lowered personal consumption expenditures to 1.4% growth in the latest GDP report. In summation, consumer spending as represented by the PCE expenditures from the BEA is an area of concern going forward.



Employment is a second area of concern. There are three areas to keep an eye on.

Construction Employment

Here is a chart from the BEA which shows construction employment since January 2001. Despite the drop in residential construction construction employment has barely dropped. There are two probable reasons for this.

1.) Non-residential construction has increased over the last year, absorbing lost residential jobs.

2.) Illegal labor's role in the construction area.



Financial services employment has shown continued advances over the last year. However, mortgage market problems started at the end of last year and show no sign of stopping. I wouldn't expect this employment sector to maintain the growth it has shown.



With the slowdown in consumer spending, retail employment has been stagnant for the last few months. A continued slowdown in consumer spending would obviously negatively impact this area of employment.



The short version is none of these areas is at a recessionary level yet. But both areas are clearly slowing in their rate of overall growth. In other words, we need to keep an eye on these levels going forward.

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Fed Retreat Has Negative Tone

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke's pledge to stop the credit-market rout from wrecking the economy failed to quell concern at the Fed's Wyoming summer retreat that the U.S. is heading for recession.

``I came to Jackson Hole thinking there would be no recession, but I'm leaving thinking we could well have one,'' said Susan Wachter, a professor at the University of Pennsylvania's Wharton School, who co-wrote the first academic paper presented at the conference.

``There are no optimists in the crowd here,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. ``There's a pretty strong consensus that this has gotten a lot more serious.''

My guess is Ben is getting an earful about what he should have done rather than what he has done. As to whether or not he will listen is a different story. In addition, there is no guarantee all of the negativity is correct. Remember, the market has been tainted by 18 years of "easy Al, and his liquidity flooding band". In other words, people are use to rate cuts whenever there is a problem in the market.

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Fed Retreat Has Negative Tone

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke's pledge to stop the credit-market rout from wrecking the economy failed to quell concern at the Fed's Wyoming summer retreat that the U.S. is heading for recession.

``I came to Jackson Hole thinking there would be no recession, but I'm leaving thinking we could well have one,'' said Susan Wachter, a professor at the University of Pennsylvania's Wharton School, who co-wrote the first academic paper presented at the conference.

``There are no optimists in the crowd here,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. ``There's a pretty strong consensus that this has gotten a lot more serious.''

My guess is Ben is getting an earful about what he should have done rather than what he has done. As to whether or not he will listen is a different story. In addition, there is no guarantee all of the negativity is correct. Remember, the market has been tainted by 18 years of "easy Al, and his liquidity flooding band". In other words, people are use to rate cuts whenever there is a problem in the market.

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Has the Fed Removed Downside Risk?

I have been thinking about his paragraph from Bernanke's Friday speech.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

I should add at this point that I am a lawyer by training, so I have a tendency (perhaps an annoying tendency) to over-analyze written statements. Hey -- that's what I get paid to do.

Anyway.....

Here's the short version: the Fed won't bail out lenders who made bad loans, but will lower rates if the current credit market problems start to slow down economic growth.

Let me play out a few scenarios that have been running through my head the past few days.

1.) Friday's employment report stinks. The market would interpret this as a sign the economy is slowing and the Fed would lower rates. Therefore, the market rallies.

2.) Friday's employment report is strong. The market would interpret this as a sign the economy is doing well; the credit market problems are contained. The markets rally.

3.) Tuesday's construction report is weak. The market would interpret this as a sign the economy is slowing and the Fed would lower rates. The market rallies.

4.) Tuesday's construction report is strong. The market would interpret this as a sign the economy is doing well; the credit market problems are contained. The markets rally.

5.) Let's say a slew of hedge funds report they have massive losses. The market would probably interpret this as a reason to rally because the cumulative damage to the markets would slow the economy.

Do you see where I am going with this? No matter what happens the lens through which market participants view the market would see a reason to rally.

Now, remember below when I was looking at the market I advanced the idea that the SPYs are currently forming a reverse head and shoulders pattern? This is typically a bottoming formation -- something that happens at a market bottom. Assuming the above analysis to be correct then we could start to see the SPYs rally from here.

Also, here are four more charts of the SPY. The first two use Fibonacci fans and the second two use Fibonacci retracements. Notice that with all of these charts the market is at a technically important Fibonacci level. That means the probability of something happening is higher to traders who use Fibonacci analysis.









As with all technical analysis, remember this caveat: the markets have many tools to make an ass out of you, and will use those tools to your disadvantage at all possible times.

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Has the Fed Removed Downside Risk?

I have been thinking about his paragraph from Bernanke's Friday speech.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

I should add at this point that I am a lawyer by training, so I have a tendency (perhaps an annoying tendency) to over-analyze written statements. Hey -- that's what I get paid to do.

Anyway.....

Here's the short version: the Fed won't bail out lenders who made bad loans, but will lower rates if the current credit market problems start to slow down economic growth.

Let me play out a few scenarios that have been running through my head the past few days.

1.) Friday's employment report stinks. The market would interpret this as a sign the economy is slowing and the Fed would lower rates. Therefore, the market rallies.

2.) Friday's employment report is strong. The market would interpret this as a sign the economy is doing well; the credit market problems are contained. The markets rally.

3.) Tuesday's construction report is weak. The market would interpret this as a sign the economy is slowing and the Fed would lower rates. The market rallies.

4.) Tuesday's construction report is strong. The market would interpret this as a sign the economy is doing well; the credit market problems are contained. The markets rally.

5.) Let's say a slew of hedge funds report they have massive losses. The market would probably interpret this as a reason to rally because the cumulative damage to the markets would slow the economy.

Do you see where I am going with this? No matter what happens the lens through which market participants view the market would see a reason to rally.

Now, remember below when I was looking at the market I advanced the idea that the SPYs are currently forming a reverse head and shoulders pattern? This is typically a bottoming formation -- something that happens at a market bottom. Assuming the above analysis to be correct then we could start to see the SPYs rally from here.

Also, here are four more charts of the SPY. The first two use Fibonacci fans and the second two use Fibonacci retracements. Notice that with all of these charts the market is at a technically important Fibonacci level. That means the probability of something happening is higher to traders who use Fibonacci analysis.









As with all technical analysis, remember this caveat: the markets have many tools to make an ass out of you, and will use those tools to your disadvantage at all possible times.

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The Week Ahead

So -- what do we look for now that the Fed has announced it won't bail out stupidity but will bail out a slowing economy? The answer is pretty simply: signs of a slowing economy.

So - next week we have construction spending, ISM manufacturing and auto sales on Tuesday. All of these are important numbers.

The Redbook is on Wednesday. This might be more important than usual.

On Friday we get employment. This is the biggie. The primary argument from the bulls is the employment situation is a strong reason why the economy is doing well. That makes this number doubly important.

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The Week Ahead

So -- what do we look for now that the Fed has announced it won't bail out stupidity but will bail out a slowing economy? The answer is pretty simply: signs of a slowing economy.

So - next week we have construction spending, ISM manufacturing and auto sales on Tuesday. All of these are important numbers.

The Redbook is on Wednesday. This might be more important than usual.

On Friday we get employment. This is the biggie. The primary argument from the bulls is the employment situation is a strong reason why the economy is doing well. That makes this number doubly important.

Read More

Last Week's Market Action

This seemed to settle down a bit last week, although there is still a great deal of trepidation out there in market land. Let's see what the charts say.

First -- here's the weekly, 5-minute chart. This is pretty straight-forward. The markets formed a head and shoulders bottom on Tuesday and Wednesday then rallied starting at the low point established on late Tuesday. Notice we have a three day rally going into a holiday shortened week.



Here's the three-month daily chart. Notice that the market is still looking for a trend. Prices are centered around the 200 day SMA. The moving averages are clustered around the 200 day SMA. However, the 10 day SMA is now sloping upward and has moved through the 20 and 200 day SMA. This is a positive technical development. Remember, in a market rally we want the SMAs to be (from highest to lowest on the chart) shorter to longer. Right now the SMAs are slowing moving back into that rally position. However, we still have a long way to go and the jury is definitely out as to what will happen in the coming month.

Despite all of the uncertainty and volatility, the market has not moved below the 200 day SMA. That is also a positive development. While traders are nervous, they have not sent the average into firm bear market territory. There is definitely a wait and see what happens approach to the markets right now.



Here's a really sharp observation that I had missed. It comes courtesy of Alpha Trends. The S&P sure looks like it is forming an inverted had and shoulders pattern right now.



Let's add some fundamental girth to that analysis. Right now we know the market is expecting the Fed to cut rates. However, I think the jury is still out on that possibility. In Friday's speech Bernanake said he would not bail out lenders who made poor loans, but he would lower rates to help the economy if the problems in the credit markets slow economic growth.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

Here's the way I read that paragraph.

1.)If the current situation in the credit markets continues the chances of the economy slowing increase. Note the word if at the beginning of that sentence.

2.)However, right now there is insufficient evidence of a broader economic slowdown that is severe enough to warrant Fed action.

Let's tie the the technical and fundamental strands together. From a technical perspective, we have a reverse head and shoulders formation forming. These occur at the end of a trend. So, the market may be forming a short-term bottom here. From the fundamental side, we have the Federal Reserve saying they will lower rates if -- going forward -- they see signs that the credit market problems are infecting the broader economy.

SO -- what are we looking for going forward to convincingly break the reverse head and shoulders formation? Any sign of an economic slowdown. And I think Barron's observation that this week's employment number is a really big key to future Fed actions is a dead-on accurate prediction.

Let me add one final caveat. The market will do everything it can to make an ass out out you. And the market has a vast array of tools at its disposal to make an ass out of you. On other words, the above analysis is nowhere near gospel -- it's just one possible perspective on things.

Read More

Last Week's Market Action

This seemed to settle down a bit last week, although there is still a great deal of trepidation out there in market land. Let's see what the charts say.

First -- here's the weekly, 5-minute chart. This is pretty straight-forward. The markets formed a head and shoulders bottom on Tuesday and Wednesday then rallied starting at the low point established on late Tuesday. Notice we have a three day rally going into a holiday shortened week.



Here's the three-month daily chart. Notice that the market is still looking for a trend. Prices are centered around the 200 day SMA. The moving averages are clustered around the 200 day SMA. However, the 10 day SMA is now sloping upward and has moved through the 20 and 200 day SMA. This is a positive technical development. Remember, in a market rally we want the SMAs to be (from highest to lowest on the chart) shorter to longer. Right now the SMAs are slowing moving back into that rally position. However, we still have a long way to go and the jury is definitely out as to what will happen in the coming month.

Despite all of the uncertainty and volatility, the market has not moved below the 200 day SMA. That is also a positive development. While traders are nervous, they have not sent the average into firm bear market territory. There is definitely a wait and see what happens approach to the markets right now.



Here's a really sharp observation that I had missed. It comes courtesy of Alpha Trends. The S&P sure looks like it is forming an inverted had and shoulders pattern right now.



Let's add some fundamental girth to that analysis. Right now we know the market is expecting the Fed to cut rates. However, I think the jury is still out on that possibility. In Friday's speech Bernanake said he would not bail out lenders who made poor loans, but he would lower rates to help the economy if the problems in the credit markets slow economic growth.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

Here's the way I read that paragraph.

1.)If the current situation in the credit markets continues the chances of the economy slowing increase. Note the word if at the beginning of that sentence.

2.)However, right now there is insufficient evidence of a broader economic slowdown that is severe enough to warrant Fed action.

Let's tie the the technical and fundamental strands together. From a technical perspective, we have a reverse head and shoulders formation forming. These occur at the end of a trend. So, the market may be forming a short-term bottom here. From the fundamental side, we have the Federal Reserve saying they will lower rates if -- going forward -- they see signs that the credit market problems are infecting the broader economy.

SO -- what are we looking for going forward to convincingly break the reverse head and shoulders formation? Any sign of an economic slowdown. And I think Barron's observation that this week's employment number is a really big key to future Fed actions is a dead-on accurate prediction.

Let me add one final caveat. The market will do everything it can to make an ass out out you. And the market has a vast array of tools at its disposal to make an ass out of you. On other words, the above analysis is nowhere near gospel -- it's just one possible perspective on things.

Read More