Risk of Recession Rising

Durable goods orders fell 1.4% in part due to less demand from oil producers for capital equipment. The Atlanta Federal Reserve said GDP for first quarter revised down to 0.2%.  The annual inflation rate is 0.0%. If the U.S. calculated inflation as is done in Europe where housing costs are not counted then inflation would be about 1.5% lower. The problem with counting housing in the CPI index is that if only a few wealthy people pay high prices for a home that distorts the market.
    The formula for estimating interest rates for the ten year Treasury is real GDP (close to zero) plus inflation (now zero). Thus a zero rate 10 year Treasury is actually logical based on traditional metrics that existed before the 2008 GFC.
   On Zillow.com there is an interactive map showing the percentage of homes with negative equity and the fall from the top for each county. Many places are still 50% below the top and still have many homes with negative equity. As a practical matter if one tries to sell then after marketing and repairs and 30 days accrued interest and transfer tax it may cost 8% to sell or even 10%. If this was added to zero equity homes with no equity then the number of negative equity (underwater) homes would be far greater.
   When society is burdened with excess debt then consumers will respond by consuming less and the economy will spiral down into a deflationary recessionary situation.
   The fact that the economy is heading into a classic recession means that corporate profits and stock prices will go down, causing people to flee into cash and bonds.
   The crucial mistake investors are making is to assume that because the Central Banks were able to print money to bail out banks that they can also increase consumer demand and make the economy return to normal. They have tried and have not succeeded at that. Such a goal can only be done by fiscal policy (either Keynesian make-work projects or Supply-side tax cuts both of which may not work in a world of excessive government spending) or by allowing the free market through austerity and entrepreneurship to slowly evolve into new markets that generate demand.
  Ironically it could be that technology, despite being feared as something that allegedly destroys jobs, could actually create jobs by creating demand for exciting new things that people never had before. If people get excited about buying a Tesla, an Apple watch, a virtual reality device, a self-driving car, a spaceship ride into space, etc. then they may spend money (because of an emotional desire) thus stimulating the economy.
   Investors need independent financial advice about the risks of the economy falling into a classic deflationary recession. Of course eventually it will recover but investors must be careful not to overpay for stocks will are now selling for roughly double fair value. Investors should move into cash and bonds and out of stocks so they can have the optionality of having cash ready to buy stocks when prices drop to fair value. I wrote an article “Prepare for the next major buying opportunity”.

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Don Martin

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