U.S. Recession In 2016? News Flash: It's Already Begun!

On December 16th, 2015, the Federal Reserve raised interest rates for the first time in almost a decade. While still extremely low by historical standards, the Fed Funds rate was effectively doubled from the old target of a 0.25% cap to the new target cap of 0.50%. Voting members at the Federal Reserve were unanimous despite recent divisions among these policymakers, some of whom preferred to wait until next year to raise rates. While Fed Chair Janet Yellen claims the Federal Reserve will remain "accommodative" in its monetary policy immediately ahead, the "small print" within the Fed's post-December meeting statement suggests otherwise. The median estimate for the targeted Fed Funds rate by current voting members of the Federal Reserve at year-end 2016 is 1.4%; and then to 2.4% by the end of 2017. This implies four separate 1/4-point hikes this coming year and an additional four separate 1/4-point hikes next year.

Quite frankly, I see almost no chance for these kind of rate hikes in 2016 or 2017. In fact, I see at least an even 50-50 probability that the Federal Reserve will actually reverse its latest 1/4-point hike in 2016, and I would not be at all surprised to see negative interest rates at some point over the next two years (in response to deteriorating economic conditions and actual recessionary forces).

Yesterday, the Institute for Supply Management (ISM) released its latest monthly Chicago Purchasing Managers report. The December Chicago PMI plunged to a reading of just 42.9, down 5.8 points from the previous month. This latest reading represented a new 6-1/2 year low and was the seventh contraction this year. It also was far below expectations of a break-even reading of 50. Readings above 50 represent economic growth and readings below 50 represent economic contraction.

The biggest contributor to the decline was a 17.2 point collapse in order backlogs, to 29.4, marking their eleventh consecutive month in contraction. December's reading was the lowest since May 2009. The index also was depressed by ongoing weakness in new orders, which contracted at a faster pace, down 5.3 points to 38.8, the lowest level since May 2009. Both production and employment also fell into contraction (below 50).

While regional indicators like the monthly Chicago PMI don't always reflect the direction of the National economy, this latest completely unexpected negative Chicago report bears more than the usual scrutiny for its implications nationwide.

I see myself as a decent market technician and better than most at reading the "tea leaves" of U.S. and global economic activity, but I can't begin to match Wall Street experts at corporate earnings estimates or supply-chain data flow. I have no "pulse" when it comes to merger and acquisition activity, and the new issue market is a complete blank to me. It was reported today that famed hedge fund manager David Einhorn posted a 20% loss in his flagship fund for all of 2015. I can say with complete certainty that Mr. Einhorn and his expert staff know more than me on almost every valuation measure and metric you can imagine. However, being the smartest person in the room doesn't always guarantee success on Wall Street. In fact, quite simply, I had a better year than Mr. Einhorn and also a better year than the average hedge fund manager who lost approximately 3% in 2015. My rate of return for 2015 on taxable funds under management was +42.58%; for non-taxable funds it was +2.23%; and the blended rate of return on combined funds was +17.54%. However, that was "yesterday", and the keys to the kingdom in this business can be elusive. 2016 is a new year, and what have you done for me lately?

Here are the annual rates of return for the major averages in 2015:

DJIA                                        - 2.23%
DJTA                                      -17.85%
S&P 500                                  - 0.73%
NY Composite                         - 6.42%
Russell 2000                           - 5.71%
Gold/Silver Index (XAU)           -34.14%
Oil Index (XOI)                         -25.20%    
Nasdaq Composite               +  5.73%

While forecasting is always a dangerous game, here are some of my predictions for 2016:

1. With the U.S. economy already in recession (in my view). GDP will actually contract in Q-1 and Q-2 to begin this new year.

2. There will be no interest rate hikes from the Federal Reserve in 2016.

3. Most major U.S. stock market averages will post at least a 15% correction in the first half of 2016.

4. The housing and auto sectors will lead the downturn in the U.S. economy.

5. The U.S. Dollar is vulnerable to a major correction in foreign exchange dealings in 2016. I think the closely watched Dollar Index (DXY) topped out at 100.60 on December 3rd, 2015 and will trade at least 10% lower at one point in 2016.

6. I believe that commodity prices have bottomed, but the expected recovery will be U-shaped and often marked by fits and starts. Copper and steel share prices look interesting to me at current depressed levels, and I am now looking to dip my toes into the energy sector despite the obvious negatives in the supply/demand picture for this arena.

7. Gold and Silver prices will be sharply higher at year-end 2016 as speculators begin to discount lower U.S. interest rates, a weaker U.S. Dollar, and even the possibility of QE4 from the Fed, but I am not ready to bet the ranch on the ultimate bottom just yet. While bearish sentiment is "off the charts" (and therefore bullish if you are a contrarian), the trader in me sees one last short-lived selling spree in these two closely watched precious metals markets.

8. Hillary Clinton will be the next president of the United States. Her victory next November will be viewed as a landslide over her Republican opponent. The perceived mandate from this landslide victory will have dramatic consequences for Wall Street. And the Health Care industry will be shaken to its roots!

Here are three very interesting charts for your review (please note the Red Dot sell signals):

Housing Sector Index (HGX) Weekly Chart with Computer-generated Buy & Sell Signals

Housing Sector Index (HGX) Monthly Chart with Computer-generated Buy & Sell Signals

NY Composite Index Monthly Chart with Computer-generated Buy & Sell Signals

The Big Short

Yesterday I went to our local theater to see "The Big Short", a fascinating and very entertaining adaptation of Michael Lewis' excellent book (by the same name) about the 2008 financial crisis. And today I listened to Dr. Michael Burry's commencement speech to the graduating class of 2012 at UCLA. In the movie, Dr. Burry is the eccentric math genius who was among the first to recognize the early signs of the sub-prime mortgage crisis that eventually served as the catalyst for the collapse of the financial markets in 2008 and early 2009. His financial success in capitalizing on his groundbreaking research is well documented in the movie, but not before he experienced the pain and suffering that almost always comes with being too early on major turns in any market. 

Even though it's now more than 3 1/2 years since Dr. Burry spoke to the 2012 graduating class at UCLA, I still feel incredibly sorry for all those students in the audience at that time who had to listen to the most depressing commencement speech that has ever been written or given to any graduating class ever! For those who wish to slog through this 22-minute speech, here is the YouTube link

If we use the U.S. stock market as our guide, the "current" U.S. economic recovery dates back to March 2009 when the S&P 500 Index bottomed out at 666.80. However, according to my research, the incredible bull market that began in March 2009 actually ended in May 2015 when the S&P 500 topped out at 2134.71. While the Nasdaq Composite Index didn't top out until July 2015, most U.S. stocks posted their 52-week highs in the first half of 2015. Of course, there is a possibility (however remote) that my conclusion regarding the ultimate top of the bull market that began in 2009 is flawed and that the final peak has yet to be set. 

In the interest of full disclosure, I currently have no short position in the U.S. stock market. In fact 90% of the funds that I have under management at this time are in cash. The remaining 10% is in relatively liquid "blue chip" corporate bonds that I have held for many years (some from late 2008 when yields surged on almost everything except Treasury securities following the Lehman bankruptcy). 2015 was among my best years ever as defined by the rate of return on funds under my management. My taxable investment funds earned 42.55% and non-taxable IRA funds earned 2.31%, which resulted in a "blended weighted average" of +17.57%. While I wish I could tell you that I have found the "keys to the kingdom" for superior money management, my computer trading system (which I personally crafted about 8 years ago based upon more than 30 years market experience) is designed to maximize profits by identifying variance-based turning points and then by using "regression to the mean" analysis to enter and exit trades. While the S&P 500 Index is basically "flat" on the year right now, there have been meaningful swings in almost every market (stocks, bonds, commodities, precious metals, and foreign currencies). In 2015, I was able to capitalize on several extraordinary price moves among mining stocks (especially in the precious metals mining sector).

My plan for 2016 is fairly straightforward: "more of the same" for my investment accounts, I hope. However, like Dr. Michael Burry in 2007, I am now extremely worried about the global economy generally and the U.S. economy specifically. I feel certain that a major liquidity squeeze is about to unfold that will inevitably lead to a greater-than-average bear market in U.S. and global equity prices. It almost looks to me as though no lessons were learned from the last financial crisis, which sets the stage for history to repeat once again.

S&P 500 Index Weekly Chart with Computer-generated Buy & Sell Signals (as of 12/25/15)

S&P 500 Index Monthly Chart with Computer-generated Buy & Sell Signals (as of 12/25/15)