The “R” Word Is Rearing Its Ugly Head
The “R” Word Is Rearing Its Ugly Head By Mark Nestmann for Nestmann
TDC Note – Well…hmmmm… recession has been with us since maybe as early as 2000 and I have been saying we are in an economic depression since about 2014-2015.
It’s here, or at least nearly here. “It,” in this case, is another recession.
We can debate the causes – an escalating trade war between the US and China, too much dodgy debt, the end of the longest bull market in history, or perhaps all three.
But all the economic indicators tell us the recession we’ve anticipated for so long is finally here:
- The yield curve for US Treasury securities has been “inverted” since June. That means short-term yields are higher than long-term yields. Inversions indicate that investors are snapping up long-term bonds in the expectation that interest rates will fall. Since central banks typically lower interest rates in a recession, an inverted yield curve is considered one of the most accurate predictors of a recession. Indeed, the last five recessions in the US have all been preceded by an inverted yield curve.
- The US manufacturing industry, which employs almost 13 million people, is now contracting. Production fell sharply in the second quarter and excess capacity is rising. Factory activity is now at a 10-year low.
- Consumer confidence is at a two-year low. That indicates US consumers are pessimistic about the economy. Americans now believe jobs are harder to find and are increasingly concerned about the impact of the trade war with China.
- Just as in the last recession, credit rating agencies are again using questionable assumptions to give trillions of dollars of credit to cash-strapped corporations. And the volume of debt rated BBB- (the lowest-rated “investment-grade” debt) has ballooned from $700 billion in 2008 to $3 trillion today. In 2007, companies rated BBB- had an average net debt of 2.1 times earnings. Today, that ratio is 3.2. And more than a third of companies with a BBB- rating have a debt-to-earnings ratio larger than five.
The most obvious consequence of a recession is increased stock market volatility. We’ve seen a lot of that lately, with the Dow Jones Industrials index falling nearly 3% on August 5.
A less visible, but equally important result of a recession will be a big fall-off in the value of bonds rated BBB-. If a sizable chunk of that $3 trillion market is downgraded to junk status, institutional investors like pension funds that are legally required to hold only investment-grade bonds will have to sell their holdings all at once. That rush to the exits could lead to enormous losses, which could happen in a matter of hours.