It is a fascinating anomaly that as the S&P 500, along with its global counterparts, has been off to the races this year, the one thing that hasn’t changed is the high (and rising) risk of a recession.
Among the most reliable leading indicators of this risk are Broadway ticket prices. The Beige Book this week was notable in this regard as it flagged a five per cent decline in average ticket prices. This is an extremely rare condition and I recall all too well when this happened back in October and November of 2007.
“Broadway theaters report that attendance and revenues were at high levels in October and early November but down a bit from a year ago,” The Beige Book reported on Nov. 28, 2007. (The recession started in December 2007.)
Few were talking about a household deleveraging cycle then, as practically nobody today is discussing the debt-laden corporate sector
On Jan. 16, 2019, it said: “Average ticket prices for Broadway shows rose less than usual this past December and were down more than five per cent from a year earlier.”
Let’s compare and contrast the environment in those two instances.
In October-November 2007, the stock market was trading near its highest-ever level. Few were talking about a household deleveraging cycle then, as practically nobody today is discussing the debt-laden corporate sector.
The U.S. Federal Reserve had stopped tightening for more than a year back then and there was some brief jubilation when the central bank began to cut rates in September.
As for the stock market, it took nine months in the 2007-08 bear phase to drop 20 per cent. It took about six months to do that in 2000-01, and less than two months in the most recent fall of that magnitude.
Things happened far too fast here, even for my cautious view, and the market has since been correcting this dramatic oversold condition in equities and all the risk asset classes that are correlated to the stock market.
For sure, some of the looming risks associated with a stubborn Fed and trade wars have been reduced, which will surely help cushion the blow. Chinese stimulus will help, too.
Some of the best days the S&P 500 and Dow have ever had were in 2002 and 2008
But, as is the case everywhere, the policy bullets in the chamber are pretty limited this time around: China and the U.S. do not have the firepower they had entering prior economic downturns and that is the overriding point.
Also recall that the most powerful rallies tend to occur after a real shellacking. Some of the best days the S&P 500 and Dow have ever had were in 2002 and 2008. Though the stock market in December behaved as it did in 1931, I assure you that we are not heading into a Great Depression this time.
The markets in general moved far beyond the economy in that respect, but instead of repricing for a turnaround in global economic growth, the depression aspect has been priced out.
Asset markets also have this tendency to overshoot. Insofar as a recession being on its way — and it is really just a matter of timing at this point — the historical record shows that once the full aspects of the downturn get discounted, we are very likely to retest (and indeed break through) those prior December lows in equity valuations.
You never have a recession without at least a 20 per cent downward move from the highs (which would be a retest) and typically the entire decline exceeds 30 per cent.
Yet this idea of a downturn is a very tough sell right now. Indeed, a colleague asked me yesterday, “So where’s your recession?”
I love this sort of sarcastic complacency because it reminds me of the consensus view in late 2007 when the economics community was calling for 2.4 per cent real GDP growth in 2008 (we ended up at -2.8 per cent); 40 per cent recession odds (they were 100 per cent as it turned out) and a 14 per cent bull market in equities (it was a -38 per cent bear market in 2008.
(As an aside, it was a bear market and recession fully three quarters prior to the Lehman Brothers collapse that triggered that last horrible down-leg.)
I wouldn’t rely too much on the yield curve not inverting either, even though segments of it already did. There were minor and brief inversions in 2000 and 2006, but the real story was just how the lags from the prior Fed policy tightenings ended up biting the economy and the markets in the tush.
As is the case when dealing with human nature, precious few ended up seeing the forest past the trees and subsequently got their heads sliced off.
Let’s all try to learn from the past. This requires discipline and a resistance to the temptation of chasing performance. Most of all, it means digging into our memory banks and thinking about what the appropriate reaction was to price cuts on Broadway in the fall of 2007, ahead of the recession almost nobody saw coming.
Also remember that back then bank CEOs such as Citigroup’s Chuck Prince were advising everyone to stick around at the dance (nudge nudge, wink wink to Jamie Dimon and Larry Fink).
David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave.