Paul Kasriel, economist at Northern Trust in Chicago, has been forecasting a slowdown in the US economy based upon his estimation that the FED has already pushed short term interest rates past the so-called neutral point. The closest Kasriel has come to the "R" word is to mention in passing a possible "growth recession" for 2006. He recommends the ten year treasury note yield minus the FED funds rate and real M2 money growth rate as leading indicators of economic growth, as indeed does the Conference Board in its Leading Economic Indicator.
In a report from this past summer http://tinyurl.com/d9oqm Kasriel overlays a chart of quarterly GDP with a one quarter forward-shifted (1QF-GDP) line which combines those two indicators above. Since 1959 these indicators turned down one to several quarters before GDP growth, and this is what we have already seen, as the 1QF-GDP and GDP growth peaked in early 2004. Each of eight prior occurences resulted in a growth slowdown and five of them led to true recessions.
Kasriel has also looked at the household (consumer) increase in debt as a percent of disposable income. http://tinyurl.com/8dhh7 In general the comments one sees on this issue bemoan the long term "implications" of this debt burden. Currently the four quarter moving average of debt/household disposable income is about 12.2%. In both 1977 and 1986 the figure was about 10.5%, so the peak of last year was not astronomically above previous peaks. Nor should we forget that debt/income fell to about 4% in 1992-93, and that it is quite cyclical with peak to peak periodicity of approximately 4-6 years. This is not a parabolic rise.
What I found more interesting than the "long run" about this debt indicator was that it peaks during the rise to, but ahead of, inflationary peaks. One could say that the household (consumer unit) begins to cut spending and pay down some debt as prices increases materially squeeze their budgets. We've been hearing anecdotal stories about this phenomenon recently with gasoline prices, but here is a data series which confirms it as a real event.
On a hodge podge chart I stacked a logarithmic Dow Jones 30 chart on top of the household debt/income chart from Kasriel on top a chart of year over year increases in CPI, on which recession periods are shaded pink or salmon. Clearly the debt/income downturns precede recessions, but even if a recession doesn't occur, there is a decline in CPI. This latter was the case in the early 1960's and 1986-87.
Even more interesting for investors is that downturns in household debt/income often, but not always, precede stock market highs. 1999, 1976, 1973, and 1955 were excellent examples. Even more compelling is the observation that upturns from lows in household debt/income occur at or shortly before market bottoms. (Keep in mind that the household debt/income chart is a one year moving average.)
While we have a downturn in the one year moving average of household debt/income from about 13% a year ago to just over 12% now, we don't of course know if this is just a wiggle in the rise from 2001 or a meaningful event which will lead to a major drop in CPI, a recession, and a major fall in stocks.
However, Kasriel's chart of M2 growth and the spread between the ten year treasury note yield and Fed funds have great reliability and are also pointing in the same direction as household debt/income.
"What does it all mean?", as my history professor was wont to ask after a long lecture. How do we take this to the bank?
My hunch is that should be looking over our shoulder as we saunter down Wall Street. If we see evidence of technical deterioration in the stock markets, given this fundamental background, we should take the money and run.
I do see some technical deterioration in a number of sentiment measures, although short term it looks quite bright. The first hour minus last hour Dow 30 price differential points to long term distribution since early last year. SP500 futures' cumulative on-balance volume line has fallen below its quarterly (65 day) averages for the longest time since the 2003 low. SP500 futures open interest has also fallen on an expiration to expiration (3 month) basis since June. And so forth.
My timing and my hunch suggest another fourth quarter run up to Christmas before a larger decline perhaps lasting through 2006. Final runs are often more powerful than one would suspect, so even if one's hunches are correct, it's best to stay the course. Then too, one's hunches may not be right.
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