When trying to time the next US recession, most economists - as one would expect - look at economic data. The problem with such "data" as last year's farcical double seasonal GDP adjustments have shown, is that if the government is intent on putting lipstick on the pig that is US GDP, it will do just that over and over, unleashing non-GAAP GDP if it must, to avoid revealing the truth until it is prepared to do so.
To avoid such purposeful obfuscation SocGen's Albert Edwards looks at places where it is more difficult to fabricate and goalseek data. Conveniently, he has discovered precisely that in what calls a "failsafe recession indicator," one which has stopped flashing amber and has turned to red. He is referring to whole economy profits data, which in his own words "shows a gut wrenching slump."
What Edwards is referring to is not that different from what we posted about back in October when we said that on 5 of the past 6 times when corporate profits dropped 60%, the economy entered a recession. This time the drop is far worse, and it's no longer just energy (the loophole used by many to explain away why in 1985 there was no recession). However, instead of looking at bottom up data, the SocGen strategist instead collapses corporate profits from the top down.
Edwards lays out the reasons why he believes that "a recession now virtually inevitable", and since this is Albert Edwards after all, he has a jovial follow up: not only will the US economy contract, it"will surely be swept away by a tidal wave of corporate default."
From his latest Global Strategy Weekly
Despite risk assets enjoying a few weeks in the sun our failsafe recession indicator has stopped flashing amber and turned to red. Newly released US whole economy profits data show a gut wrenching slump. Whole economy profits never normally fall this deeply without a recession unfolding. And with the US corporate sector up to its eyes in debt, the one asset class to be avoided – even more so than the ridiculously overvalued equity market - is US corporate debt. The economy will surely be swept away by a tidal wave of corporate default.
The temper tantrum risk assets threw at the start of the year was sufficient for the Fed to backpedal furiously on rate hikes. Like the Grand Old Duke of York, the Fed marched us up to the top of the hill and then down again - at the behest of the markets. And as more and more contorted excuses are wheeled out to justify its inaction we all surely know by now that the Fed's articulated "data-dependent" rate hikes are primarily focused solely on the level of the S&P, i.e., when it slumps they will quickly back off rate hikes and use any excuse necessary including dismissing surging core CPI inflation. How sad that Central Bank policy should have come to this.
I suppose now the S&P has recovered we are about to go through another turn on the monetary/market merry-go-round. Ignore this noise. Recent whole economy profits data show that while the Fed plays its games, the economic cycle is withering and writhing from within. For historically, when whole economy profits fall this deeply, recession is virtually inevitable as business spending slumps. And if I had to pick one asset class to avoid it would be US corporate bonds, for which sky high default rates will shock investors.
We have written extensively in the past as to why sell-side economists almost to a man and woman fail to predict recessions. One of the key reasons - aside from the obvious wish not to make an unpopular call that might prove wrong and likely fatal to their career - is that they do not place enough importance on the role of profits as a driver of the economic cycle.
My own observation has led me to the conclusion that when whole economy profits begin to fall sharply, this is usually followed shortly after by the overall economy tipping over into recession, driven by the volatile business investment cycle. The national accounts, whole economy profits data give a wider and "cleaner" estimate of the underlying profits environment than the heavily doctored "pro-forma" quoted company profits data (the former also often leads the latter). As illustrated below, a longer term chart shows how whole economy profits tend to be a leading indicator of the business investment cycle. It also shows the current profits downturn is notably worse than the 1998 downturn - which is often cited as evidence that a profits recession does not necessarily lead to a full blown economic downturn.
At this point Edwards observes that some fellow skeptics like Gerry Minack do not see a recession as imminent (he sees a stagflation). However, he remains adamant: "My own view is that Fed tightening may not be a necessary condition to catalyse a recession and that the deep profits downturn is sufficient in itself. Historically all recessions are effectively caused by slumps in business investment driven by a profits downturn: the chart below shows that whenever GDP growth (dotted line) is negative it is almost totally overlaid by the contribution of GDP growth in business investment (red line)."
Will Edwards be right? Of course, but at that point the government - which needs to preserve confidence in growth at all costs - will simply change the definition on GDP first, and when that fails, of "recession" next. And all shall once again be well.
—> Full note from Albert Edwards attached
US whole economy profit slump makes a recession now virtually inevitable
Despite risk assets enjoying a few weeks in the sun our failsafe recession indicator has stopped flashing amber and turned to red. Newly released US whole economy profits data show a gut wrenching slump. Whole economy profits never normally fall this deeply without a recession unfolding. And with the US corporate sector up to its eyes in debt, the one asset class to be avoided – even more so than the ridiculously overvalued equity market - is US corporate debt. The economy will surely be swept away by a tidal wave of corporate default.
The temper tantrum risk assets threw at the start of the year was sufficient for the Fed to backpedal furiously on rate hikes. Like the Grand Old Duke of York, the Fed marched us up to the top of the hill and then down again - at the behest of the markets. And as more and more contorted excuses are wheeled out to justify its inaction we all surely know by now that the Feds articulated data-dependent rate hikes are primarily focused solely on the
level of the S&P, i.e., when it slumps they will quickly back off rate hikes and use any excuse necessary including dismissing surging core CPI inflation. How sad that Central Bankpolicy should have come to this.
Emerging markets have recovered particularly well, with inflows surging last month to a 21-month high according to the Institute of International Finance (IIF). The esteemed folks at PIMCO are putting that down to the three Cs: China, Commodities and Central banks. Personally I think the first two Cs are very much driven by the last C, or indeed just the Fed. The IIF reports that inflows into EM rocketed in the two days after the Feds March meeting.
At the same time the US dollar slumped, hence relieving downward pressure on both commodities and the Chinese renminbi.
I suppose now the S&P has recovered we are about to go through another turn on the monetary/market merry-go-round. Ignore this noise. Recent whole economy profits data show that while the Fed plays its games, the economic cycle is withering and writhing from within. For historically, when whole economy profits fall this deeply, recession is virtually inevitable as business spending slumps. And if I had to pick one asset class to avoid it would be US corporate bonds, for which sky high default rates will shock investors.
