A coming recession – or a depression?

It seems markets have never been so divided as we kick off the new year. The bulls are looking at the Fed hiking rates up to the ‘termination point’ – currently around the 5% Fed Funds mark – from where they will retreat – and re-ignite a strong bull phase.

They point to falling commodity prices and the easing of consumer price inflation. And to the ‘strong’ jobs market, although the official data on employment is in severe doubt.

Then the bears point to Big Tech which is being clobbered as interest rates rise and now massive lay-offs are in force. They ask will this be replicated in the wider economy as the much-anticipated recession gets under way.

There is one recession indicator with a 100% track record – the yield curve inversion. It has forecast 100% of all US recessions since at least the 1950s. And the gap in US Treasuries at 80 bps is the widest since the heady days of 1979 when rates were sky-high to ‘combat inflation’.

I believe this huge gap signals a much deeper recession this year than most project – and a likely move deeper into the depression conditions I have been warning about for some time.

Here is the Fed’s estimate of the recession probability since 1959. At the 40% level it is back at previous recent highs (resistance). The bulls believe it will fall back from here. Of course, any advance would sent it above this level. Hmm.

Interestingly, this yield curve inversion indicator was widely discussed in the MSM at the October lows but has fallen off the radar as stocks have rallied – until last week.

This is a clear indication that bullish sentiment has recovered strongly and one example of this is the opinion of a leading economist that promoted the yield curve inversion indicator previously and has now rejected it. He cites various factors that he says negates the signal this time. It’s the old ‘it’s different this time’ mantra. And that too has a 100 % track record – of being wrong.

Yes, when bullish fervour runs rampant, you can make all kinds of excuses for ignoring what a 100% accurate indicator is telling you – a signal that is highly inconvenient to your bullish mood. And this bullish mood has engineered a chunky Fib 76% Dow retrace of the entire bear market off the January 2022 ATH high to the October low. That is some faith in the future. Meanwhile the Nasdaq still tests new lows.

This is a very fractured – and thus unhealthy -stock market.

But that does not preclude stocks moving higher near term (as they did yesterday – see below). As I noted last week, the MSM had become pretty gloomy and that is a recipe for a bounce.

But all that does is tee the market up for another disappointment when reality strikes. One measure of the approaching carnage is summed up in this chart of ‘zombie’ companies (which are companies where the interest payments on their debt exceeds their revenues).

Now at an astonishing 24% of all companies in the Russell 3000 – and shooting higher – a deluge of bankruptcies loom.

When that hits the MSM, shares will be a lot lower.

And that little observation above about the peculiarities of human nature is at the bedrock of what makes markets move the way they do as they gyrate in the the swings of bull and then bear trends.

And using my Tramline method of analysis can put odds on your side of correctly anticipating the next move (see below).

Yes, the macro data is important, but only to the extent of what traders make of it. Before trying to analyse it yourself, it is a lot more fruitful to observe what others think of it and how they react.

So for this and other reasons, I maintain my bear market rally thesis. And as night follows day (it always has), when bullish sentiment becomes extreme the rally is unsustainable and starts a reversal. That is usually when conditions appear wonderful for further advances.

Yes, the trading gods have a highly developed sense of irony. And remember, markets exist to frustrate the majority.

What are Treasuries signalling?

It is often said that the bond traders are a lot smarter than equity traders. And that means it is good to understand what the bond markets are telling us, if anything.

The long T-Bond yield contains two moving parts – the short term interest rate and the inflation expectation element. We know the first part with accuracy but not the second nearly so well, but we do have clues.

For one thing, inflation expectations are highly geared to the crude oil price since that commodity plays such a crucial role in the economy. And crude prices are in a steep decline. On the face of it, this confirms the weak outlook for the economy as demand is falling. In recessions, commodity prices usually decline. And that ties in with the yield curve inversion signal.

This is the chart I sent to VIP Traders Club members last week alerting to a likely strong advance

The big pattern is an A-B-C with the ‘B’ wave just completed leading to a likely large advance (decline in yields) in a ‘C wave. This ‘C’ wave should comprise five sub-waves and could move above the ‘A’ wave high since the short interest by managed money (hedge funds) is extremely high and a massive short squeeze could be on the cards.

And yesterday’s Non-Farms report was received rapturously leading to strong stock and bond gains. That nicely confirmed the Buy Signal on T-Bonds above with my pink target being well and truly hit (with a little bonus).

As for US shares, this was one option I had in last week’s blog for the Dow

and this is how the week played out

It rallied yesterday to the first target at the Fib 50% retrace and will either resume the decline in a third wave from here or perhaps from the higher Fib 62% area if there is more wind in the sails.

Note that both bonds and stocks rallied in unison yesterday in keeping with the pattern established last year when the 60/40 investment rule was dashed on the rocks of surging interest rates coming off the zero bound (see last week’s chart of how the Fed follows the market-set 6-mo T-Bill rate).

And if this pattern is maintained as I expect, when stocks resume their decline, so will the T-Bonds – and that will likely occur when energy prices start to rally of their floors.

Of course looking ahead, if a deeper recession/depression does arrive, assets of all kinds will be sold sometimes in a panic. And it is not clear that ultra ‘safe’ US Treasury bonds will escape the rout. With general debt levels still high, a period of elevated interest rates will force some asset holders out of the market and this could easily snowball into bonds.

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Some bombed-out shares are now worth looking at

In the meantime, many bombed-out UK shares are simply asking to be looked at afresh. I am wondering just how much lower can some of them go? I know that is always a question that begs the answer: Very much! But here is one I am advising for Pro Shares members.

The old war horse BT Group has just made a two year low at 110p. It pays a healthy dividend of 6% on a P/E of only 7 and although there are question marks about the status of Open Reach, the major UK broadband provider, its often a good time to buy when there are such question marks and the price is low. This is in reality a utility company like water but with pricing power. If the market rallies despite the ‘problems’, that could be a great sign to expect a decent investable advance.

Here is the 2-hr chart showing the 110p low made on 12 December. But after that, the market has made a textbook 5-wave triangle bottom formation when the market broke out sharply on Wednesday. That was a very clean Buy signal. The shares have advanced 20% already.

The advance has been almost vertical and that tells me is it is most likely a motive wave (trend is now up). So up she goes!

One more bear market pointer

In bull markets, financial (and other) crimes are mostly covered up, excused and generally swept under the carpet. Very few major criminals are either punished or even investigated. But that changes dramatically when the bear trend is in force.

And one of the greatest crimes in finance today has to be the on-going crypto FTX drama that was uncovered last year when the new bear market was getting under way. That is no accident of timing. With social mood now darkening, the criminal justice system has swung into action where previously they sat on their hands.

Now having been arrested Sam Bankman-Fried may suffer a fate in keeping with the last part of his name as he is now under extreme heat.

With the shady nature of crypto, I am confident a lot more scams will be uncovered in the months ahead. After all, the word ‘crypto’ means hidden, secret, under cover – a fertile breeding ground for fraud.