From The Reformed Broker:
What could go wrong?
The Fed is DJing the hottest dance party ever, and everyone is getting down. Well, not everyone, but you get the idea. Anyway, if there's anything that could derail us, it's an ordinary, cyclical recession. The kind we used to have before Greenspan decided they were no longer necessary.
Today, I'd like to talk about the relationship between earnings recessions and economic recessions. Because we're beginning to have the former, which typically leads to or coincides with the latter. Don't get mad, that's what the data says.
This is important because stocks should not continue to climb under these circumstances. Note that I said "should not," not "will not." Seth Klarman of the Baupost Group would agree with me. Here's what he told his investors in a letter the other day (via Distressed Debt Investing):
"The overall market environment seems increasingly risky to us, as securities prices are rising despite weak and generally deteriorating global fundamentals. U.S corporate earnings are expected to be lower this quarter. Higher markets in the face of eroding fundamentals can be a toxic combination. A market rising for non-fundamental reasons (i.e., QE and ECB bond repurchases) is always one that demands a healthy dose of skepticism."
Back to the dancefloor...someone's just whispered fire. But that whisper is being echoed across the financial web, transmogrifying with each utterance from whisper to scream. The whisper is a recession prediction, attached to which is a probability of 100%. What's worse is that it comes to us originally from a Fed researcher and it's an empirically driven call, not an opinion.
Now, predicting recessions is typically a sucker's game – no one alive has a consistent record of doing it in a timely fashion. And by the time NBER weighs in with the official start date, you're typically two-thirds of the way through anyway and stocks are already rebounding.
That being said...
The evidence of an impending recession has been piling up of late, and to pretend otherwise because you're afraid of the word would be rather silly. In addition, just because the evidence is piling up, that doesn't mean we can't avoid one in the short term. Of course that's possible – especially with the Fed in full-on business cycle perversion mode.
But the odds of being able to avoid one continue to get slimmer. And whatever happens with this Fiscal Cliff mess, the plain fact is that it is guaranteed to do one thing: bring us closer to contraction than expansion no matter who gets the upper hand in the final negotiated bipartisan mercy-fuck.
Tax hikes and government spending cuts separately, with GDP growth running at sub-2%, will typically push us into recession. But combined? They virtually guarantee it. Raise your hand if you think the Cliff is resolved without both of those things being in the mix...didn't think so. But don't worry, the Fed can always cut rates to offset this change in fiscal policy. Oh wait...
See what I mean? Add in the international stuff and its hard to see how U.S. housing's newfound relative stability alone can save us.
But what is this aforementioned evidence, you ask, that has been piling up? Let's walk through some of the important stuff together...
More on earnings: