Bank of America: "Imminent Recession"

Posted by Patrick Ceresna on Oct 21, 2016 9:30:41 AM

Bank of America's Savita Subramanian issued an overnight note titled "Is it about time for a recession?".  In the note, is suggests that they found evidence for an imminent recession.  Suggesting that if data were to continue to weaken in line with the recent pace, history would point to a recession in the second half of 2017.  Further explination suggests that not every bear market coincides with a recession, but the most painful ones do.  But my favorite part is that they caution Bank of America's long-term oriented investors from going to far in reducing their equity exposure suggesting that unless you can pinpoint the peak of the market within a 12-month timeframe, you are typically better off staying invested.

Ceresna Comment: Let me summarize.  There is risk and a lot can go wrong and it is imminent.  But don't worry, just buy and hold for the long-term.   Thanks for the advice Bank of America, but I think I will let you and your clients hold the bag on the way down.

Original Source: zerohedge
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Admittedly, other macro indicators, such as consumer confidence and initial jobless claims, still point to healthy growth. But historically, equity returns have been strongest prior to the peak in building permit issuance growth (2012 in this cycle) and the probability of a bear market has been high when the yield curve was inverted (not until 2018 based on the trend).

 What if current trends persist? We chose five macro indicators and determined what levels tended to coincide with historical recessions and bear markets. While we are cognizant that trends change and that relying on the recent trend can often give you false signals when trends reverse, we also think that there is some value in considering what might happen if the current trends were to persist. In this exercise, we extrapolated the trends over the last few years in an attempt to estimate when the recessionary thresholds will be breached. In this scenario, the range of  potential recession start dates implied by these models was as early as July 2016 and as far off as April 2019, with an average start date of October 2017.

If BofA is right and if a recession is coming does that mean that a bear market is imminent? As Subtamanian explains, not every bear market coincides with a recession, but the most painful ones do. Standard & Poor’s identifies 13 bear markets since 1928, of which 10 have coincided with US recessions. The exceptions were 1961, 1966 and 1987, which precisely because they did not occur alongside recessions, were relatively short-lived and followed by swift recoveries. The general rule of thumb is that the stock market leads the economy by 1-2 quarters, and on average, the market has historically peaked 7-8 months before a recession. But the range has been remarkably wide, from the peak of the market coinciding with the start of the recession and as early as 2.5 years before the start of the recession (1948).

bear vs recession_0.jpg
Furthermore, not every recession comes with a bear market, especially the short ones There were several recessions where the market declines have been modest (i.e. less than 20% bear market declines), as in 1945, 1953, 1959 and 1980 (and technically 1990, which was 19.9%, but is generally considered a bear market). These non-bear market recessions tended to occur when the recessions were short and/or market valuations were low.

This feeds back to BofA's analysts because as it writes, the macro indicators the bank looked at tend to coincide with recessions more than bear markets, although some of them were also able to capture some of the nonrecessionary bear markets (although usually with a lag). For example, building permits signaled the non-recessionary bear markets in 1967 and 1987 (Chart 25), while the yield curve also signaled the 1967 bear market (Chart 21). The yield curve and building permits appear to have the most predictive power with respect to bear markets, although both have instances where they failed to trigger our bear market signals. Additionally, the yield curve had one case of a false bear market signal in 1978— although some would argue that it was simply too early relative to the 1980 bear market. And in many cases, the signal occurred after the market had already peaked. But based on this exercise, our indicators suggest that the start of the bear market could come in the middle of next year.

Some of the best returns often come at the end of bull markets, and these gains are usually enough to offset the subsequent losses. Over the last 80 years, the minimum equity market returns achieved in the final two years of a bull market were 30%, with median returns of 45% (vs. 17% preceding the August peak); returns preceding the 1937 and 1987 peaks were particularly strong: 129% and 93%, respectively (Table 5). The returns in the last two years have averaged over 40% of the total returns of the cycle. Similarly, the lowest returns achieved in the last 12 months of a bull market were also impressive at 11%, with median returns of 21%. These robust returns suggest the opportunity cost of selling too early is quite painful.

Topics: Recession

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