Call it a major hangover. The reversal in tariffs did not come from a position of strength. It came as a result of global economic reality sinking in and crushing US markets.
Turns out trade wars are not easy to win and the global growth picture is not looking good. Last week, the UK announced negative GDP growth for the past quarter. This week, it’s Germany announcing shrinking GDP with its 10-year bond hitting a record negative 0.62% yield. Then there’s Europe seeing negative industrial production, and China announcing its lowest industrial production growth in 17 years.
The collapse in global bond yields has been a theme since October of last year, with 10-year US Treasury bonds dropping to 1.6% from their October 2018 high of 3.23%. Now that the two-year/10-year Treasury yield curve has inverted, the recession alarm bells are ringing. Why? Because every single recession in the past 45 years has seen a yield curve inversion preceding it.
History suggests that on average a recession begins 22 months after a yield curve inversion. It’s not until about 18 months after an inversion that the stock market turns negative.
Yet Bank of America Merril Lynch numbers indicate that we have less time. For the 10 yield curve inversions since 1956, the S&P 500 peaked within approximately three months of the inversion six times. Following the other four, the S&P 500 took 11 to 22 months to peak.
Twenty-two months of growth vs. three months? That’s quite a big gap.
Both of these historical studies suggest there is room for markets to make new highs in the next few months. In fact, one can imagine several scenarios on how these new highs could come about.
Central banks could embark on emergency interest rate cuts and reintroduce quantitative easing programs to force more cash into equities again. A sudden end to a trade war, with an attempt to save face by both sides, could certainly spark a sustained global relief rally that may end up averting or delaying a recession.
Indeed, the Trump administration, eager to avoid a recession ahead of the 2020 election, may find itself in a position to end the trade war sooner rather than later. But the administration is still faced with several historic miscalculations of its own making. The massive tax cuts of 2017 have produced little in the form of growth other than a temporary sugar high. Growth is slowing. Long gone are the promises of 4% GDP growth. In fact, growth is looking to drop below 2% in lieu of a trade deal. The only thing that has been growing are deficits, which are on pace to hit $1 trillion this year already.
All of these are signs that the risk of a global recession is a clear and present danger.
This is a very tricky environment for investors to navigate through. History suggests there is time to take advantage of future rallies to prepare for the next recession and raise cash before a major market downturn does unfold. But global economic data suggests a global recession may come a lot sooner than anyone anticipated.
And this reveals an uncomfortable truth: We’ve never faced a recession with so much debt and so little Fed ammunition available and with negative rates still in effect in many countries. There’s no playbook for this. Historic data may be of little predictive use.
A sudden end to the trade deal may be imperative — without it we don’t have much time before the next recession begins.
Read more at CNN.com