Yesterday, we looked at how and why the Yield Curve implies a "Probable Recession."
Today, we go to Merrill Lynch’s North American Economist, David Rosenberg, who observes that: "Our recession-risk indicator puts the probability that there will be an economic downturn in the coming year at 51%. That’s the highest level since the 2001 recession."
Now, its one thing for our little blog here to say a recession is becoming increasingly likely — I’m more in the 60% camp myself. Indeed, back in the Summer of 2005, we identified that a late 2006/2007 recession was increasingly possible.
But Merrill Lynch manages a trillion or so dollars, and its worth noting when their economist foresees an increased possibility of recession.
Here are the factors Rosenberg identifies as influencing his thinking:
• "The Institute for Supply Management’s (ISM) purchasing managers’ index came in at a weaker-than-expected 51.2 for October, down from 52.9 in September. The consensus was 53.0."
Rosenberg notes that in the past, whenever the ISM index hit 51.2 while in a downtrend, it eventually broke below 50 — the dividing line between expansion and contraction in industrial activity. Rosenberg adds that "once it does that, history shows that the Federal Reserve cuts rates within two months." Therefore, watch the 50 level on ISM to help forecast the next rate cut.
• "Our recession-risk indicator puts the probability that there will be an economic downturn in the coming year at 51%. That’s the highest level since the 2001 recession."
This is a proprietary indicator, so I plead ignorance as to its components. Rosenberg does note that historically in all but 2 times, it accurately forecast a recession (knowing out of how many signals would be helpful). The average lead time between the penetration of 50% and a recession was 12 months, and the median was 10 months. That would put the ML recession (only 51%) somewhere in September-November 2007, and the market reaction sometime between March and May 2007.
More factors:
• "We think GDP will grow at an annual rate of roughly 2% for the fourth quarter, and the risk is on the downside in light of the weak "handoff" in terms of macro momentum as the quarter began and what we know so far anecdotally about spending in October."
• "Our 2007 GDP growth estimate of 2% hasn’t changed, but keep in mind that our forecast assumes that the Fed will cut the funds rate to 4% next year. Without that stimulus, growth could well be closer to 1.0% to 1.5%. That would be weak enough to be in the hard-landing zone that sees a sharp reversal in the unemployment rate and the emergence of credit problems"
This is premised on a few factors: No major new stimulus, externalities, oil shocks, etc.
>
Source:
Risk of Recession Builds
David Rosenberg
Merrill Lynch, November 3, 2006
http://askmerrill.ml.com/res_article/1,2271,19598,00.html
the Chicago PMI trend forecasts ISM that will go below 50 in its next series ….. and the Fed’s never raised rates when ISM is below 50 …. stay long TLT’s
I think we are entering the same type of trading as last May where we slowly creep up and up and up. The market slowly becomes more and more complacent and less volatile as we enter a period of melt up and the last wedge.
It will baffle many probably because we will be hearing about weak economic numbers during this period. Then some catalyst which is not so significant rather just an excuse to sell will cause the steep selloff.
I like to fantasize.
It’s not hard to fantasize. Pelosi launches investigations of money connection between $B’s in DOD/DHS IDIQNB contracts, Cheney’s Halliburton, Bush’s Carlyle Group.
January new hiring capital investment comes in low on the potential for a significant business downturn. War in Iraq/Iran steals ever more and more of the financial headlines to hide the first drips of US$’s glacial calving.
At that point, anyone who wants to can pull the trigger.
?Is it any wonder Carlyle hired away Deutsche Bank’s currency hedge fund expert, and like Soros and Buffet, setting long puts / short calls on our American Dream.
There must be something weird about the numbers being put forward.
Consider, supposedly the risk of recession according to the proprietary indicator is 51%, but it has only been in error and wrongly predicted a recession twice.
Does this mean that there are four and only four instances of this particular number being produced by the model, and that two were followed by a recession and two were not?
Four instances is not very many, and any prediction based on only four instances is suspect.
On the other hand . . .
If the Merrill Lynch model (or indicator)–in its current state–had made ten predictions of a recession, then, we would conclude, not that there was a 51% chance of recession, but that there was an 80% chance.
Perhaps was Rosenberg means is that there have been a dozen predictions made by the model in the past hundred or so years (backtested), but that at different times, the % risk of recession according to the model was anywhere from 30% to 99%. And, of these, the model was only wrong twice?
Or, does he mean that in the last 15 years, ML has created a proprietary recession risk indicator, and that,
going forward from the time it was created, the model has only been wrong twice? In that case, I’d have to ask when the model or indicator was created. If the model was created in 96 and has been wrong twice since then, it is wrong more than it is right. No?
Note to Barry (somewhat off topic)
Are you going to smoothly ignore the bearish outlook you’ve had throughout 2006 or issue a mea culpa at some point on in time and admit that the market fooled you this year ?
I still think you are insightful and entertaining but the recent rally has been a shock to my notion that the market runs on rational pricinciples.
ML model is also based on the “Fed model” using the the shape of the yield curve as key (and only?) input. This is more a rule of thumb than a “model”.
And it is not because ML manages trillions of dollars that their prediction is more robust. Morgan Stanley’s Stephen Roach has been wrong for years.
NN
Yes, i am working on one for Real Moeny — what the Cult of the Bear got right and got wrong — and what might happen going forward
I’m more in the 60% camp myself.
60% chance of a recession as defined by whom, Barry? John Williams’ “Shadow Government Statistics” have us in a recession since last year.
Apparently you buy Wall Street’s view that it isn’t a “real” recession until the government says it is so, no matter how far they twist the numbers to deny it. If you are truly that gullible, why do you ever bother quibbling over any government-issued statistics??
I’m more in the 60% camp myself.
60% chance of a recession as defined by whom, Barry? John Williams’ “Shadow Government Statistics” have us in a recession since last year.
Apparently you buy Wall Street’s view that it isn’t a “real” recession until the government says it is so, no matter how far they twist the numbers to deny it. If you are truly that gullible, why do you ever bother quibbling over any government-issued statistics??
I’m more in the 60% camp myself.
60% chance of a recession as defined by whom, Barry? John Williams’ “Shadow Government Statistics” have us in a recession since last year.
Apparently you buy Wall Street’s view that it isn’t a “real” recession until the government says it is so, no matter how far they twist the numbers to deny it. If you are truly that gullible, why do you ever bother quibbling over any government-issued statistics??
I’m more in the 60% camp myself.
60% chance of a recession as defined by whom, Barry? John Williams’ “Shadow Government Statistics” have us in a recession since last year.
Apparently you buy Wall Street’s view that it isn’t a “real” recession until the government says it is so, no matter how far they twist the numbers to deny it. If you are truly that gullible, why do you ever bother quibbling over any government-issued statistics??
I’m more in the 60% camp myself.
60% chance of a recession as defined by whom, Barry? John Williams’ “Shadow Government Statistics” have us in a recession since last year.
Apparently you buy Wall Street’s view that it isn’t a “real” recession until the government says it is so, no matter how far they twist the numbers to deny it. If you are truly that gullible, why do you ever bother quibbling over any government-issued statistics??
If we are to read the tea leaves on the recession prior to the “official” announcement which means we’ll be halfway through the damn thing before we acknowledge it? As I was looking at Marty Zweig’s conditions of a bear market, he notes that one characteristic is extreme deflation characterized by a PPI index drop of 10% on a 6 month average of annualized m-t-m changes. Take current year m-t-m inc/dec and average it with the last 5 months (sum the mtm change each month for the last six months and divide by 6). If that 6 month average is at least –10% then we’ve cleared this test. I would presume that if this were to happen we could safely say that along with an inverted yield curve that we’ve passed two critical tests.
The decline in the housing market is going to cause a dramatic wealth effect starting early next year. I don’t see how this could not happen given the fact that housing prices are actually declining on a nominal basis. I predict that the stock market will start responding this month or next month and not much later. 1.6% growth in the 3rd quarter was actually 0.9% without the abnormal truck sales number. That is not impressive at all. An interesting question is what will happen to the dollar in 2007 when the recession does occur. Will it continue to be held up by foreign central banks or will there be a crash of the global eocnomic system?
“The decline in the housing market is going to cause a dramatic wealth effect starting early next year.”
i’m more worried about what the fed is going to do about housing. they know it’s bad. they know it’s going to get uglier. MUCH uglier.
and when things get ugly, they do what they always do: add liquidity and slash interest rates to bail out the consumer. i can’t see them standing by, and letting that level of carnage play out unabated. cutting rates is their only option. besides, i think we all know how “mr. helicopter” likes to tackle sudden deflationary cycles.
if housing gets as bad as roubini, et al., say it will, interest rates will *plummet*, along with the greenback. and if that’s the case, this GLD rally has got more room to run…
the only question is: how drastic the cuts will be, given the recent moderation of inflation. my guess is more drastic than the “Goldilocks” crowd thinks. the inversion will continue to get worse before it gets any better.
anyway, the moral of the story is: never bet against the bond market…
I agree that the real estate market still has quite a bit of correcting to do, and that the Fed knows this BIG TIME.
I think it is foolish to think the real estate correction is “in it’s last throes”.
I don’t think the potential negative wealth effect can be stressed enough. These are not 401K’s we are talking about, and we shouldn’t focus too much on speculators flipping properties who are now getting taken to the woodshed. The average homeowner is the one to keep an eye on. And they are cash strapped, with zero in the bank, and have cashed-out equity driven this economy for a good while now.
This could take a decade to recover from economically.
Finally, when everyone knows of someone or a friend (non-speculator) who has literally lost their home, the tone will be very different. Such a tone could be described as a “Malaise”. John Mauldin’s musings seem to come to mind.
I will say one thing about Pelosi.
She must have one huge set of t-i-t-a-n-i-u-m nuts bigger than a 15-year-old squirrel’s… and they don’t usually live longer than about 4-5 years, if you catch my drift:
http://en.wikipedia.org/wiki/Squirrel
I think she’s plannin’ on kickin’ ass and takin’ names.
If she swings Murta to Majority Leader in Day Uno:
http://www.rollcall.com/issues/1_1/breakingnews/15974-1.html
… it’ll be like taking a Roger Clemens first pitch, a high and tight fastball, and driving it deep into the left field upper deck….
….. Otherwise, it’ll be the first big fat softball she serves up to the Neo-Cons.
Slowdown YES…recession…not so fast:
“The outlook for industrial output growth is lackluster,” says Anirvan Banerji, director of research at the New York-based Economic Cycle Research Institute and a RealMoney.com contributor.
Banerji cautions that other recent data showing growth of U.S. industrial production in September at a six-year high of 5.6% is misleading, in part because of the favorable comparison related to a dip in output a year ago because of Hurricane Katrina.
What he’s focusing on is a smoothed industrial-production growth rate of 3.4% for September, down from 6.2% in June. “The rate of growth has slowed quite distinctly and is poised to go down further,” the cycle watcher says, although Banerji doesn’t see it going negative just yet.
ECRI also says its Weekly Leading Index for the period ending Nov. 3 rose 0.3%, following 14 straight weeks of declines, although Banerji says the change is only marginally significant. The prior period showed a decline of 0.3%. ”
Note to self…watch employment, CP market, business loans, credit spreads, and the consumer to see evidence of a further slowing (or a recession). The rest is noise. The stock market is smelling a whiff of an easing cycle. Ignore that force at you own peril. The yield curve has inverted from a supply / demand anomoly — petro and Sino dollars. I expect them to shift (not swap) new dollars into large cap equities. They have no interest in abandoning the greenback, and killing their own customer. I expect a positive sloped curve by early March.
I don’t see how the FED can lower rates w/ the UK and ECB still raising. They’d be much more concerned about a $ collapse than a housing bust. IMHO
(Though it’d be good for my gold stocks)