Category Archives: Recession


The Important Insights From The FOMC Minutes No One Is Talking About

  • The FED’s “protect the market at all costs” attitude minimizes the risk of a severe bear market but increases the risk for an inflationary environment.
  • Trade deficits and low productivity are not good signs for the long-term, no matter the positive data from the labor market.
  • Until the focus shifts from central banks to real structural reforms, sluggish GDP growth could easily turn into a recession.


There are more important insights that can be gained by going through the FOMC minutes than by just reading the news about an eventual interest rate increase. An interest rate increase of 0.5% won’t change much. It will give the news something to talk about for two weeks and from then onwards it will be business as usual. Structural risks and what the FED is ready to do or not do in the case of turmoil is what will determine our investing returns.

The Patient Needs Stronger Medicine

The FOMC minutes start with a discussion about the implementation of a monetary framework, clearly stating that since the 2009 crisis, heavier intervention is needed to stabilize the markets and the economy. Before the crisis, a few rate cuts or increases and minimal market asset purchases were enough to reach stability. This can be clearly understood by having a look at the FED’s balance sheet. It increased fivefold from 2009 to 2014.

figure 1 fed balance sheet
Figure 1: FED’s total assets. Source: FRED.


For investors, this is important because it tells us that the FED will use all the tools at its disposal to keep the economy and markets stable. This minimizes the risks of a severe bear market as capital injections will be immediate, but it also increases the risks for an inflationary environment.

The Economy & Inflation

The economy shows mixed signs. On one hand it is doing very well with the latest jobless claims data at only 262,000, extending the period below 300,000 to 76 weeks which is the longest since the 1970s. On the other, weak manufacturing data, a trade deficit and growth from consumption alone keep the FED from decisively increasing rates.

The unfortunate thing is that adding jobs is easier than solving structural issues. With low productivity and a trade deficit, it is difficult to expect miracles from the U.S. economy in the long term, which again indicates that some international diversification and inflation protection should be welcome in the long term.

Inflation is still only at 1% indicating that something isn’t working as planned. Low interest rates and lots of cheap capital have spurred investments which increases the supply of goods, sending prices down, not up. Such a situation enables the FED to keep rates low and sustain the economy, but nobody knows how long such a situation will last. The FED is just postponing the reach of the 2% inflation target, which is now set for beyond 2018.

The sluggish GDP growth forecast and an economy relying on easy-to-hire jobs and consumer spending indicates that monetary easing did what it can do and now it is time for something else to step in. Structural reforms, lowering student debt and investing in infrastructure might be reasonable ideas, but until the focus is on monetary policy, the risk is high that this slow growth will turn into a recession.

The Situation in Europe

The European central bank released its policy meeting minutes a day after the FED. Europe is still a few years behind the U.S., asset purchases and direct financing programs are the norm but have no influence on inflation or economic growth. Inflation in the EU zone is at 0.8% while industrial production is contracting and GDP growth is below 1%. For the ECB, the good news is that unemployment has decreased from 10.2% to 10.1% and youth unemployment is “only” at 20%.

Similar data clearly indicates that other actions are necessary for the reach of sustainable economic growth. The terrible unemployment rate signals severe structural issues that cannot be amended by monetary policy. At least the situation in the U.S. looks much better after taking a look at Europe.


Everyone expects miracles from central banks, but those miracles only work for a short while. Hopefully structural reforms will enable future economic growth. Until then, we have two situations on our hands as investors.

  • Situation Number 1 – Central banks will intervene at any sign of market and economic weakness with more stimulus, minimizing the risks for long term investments. This means that we can stay long, but we have to be careful to watch for the point in time when the majority of people in the markets understand that monetary policies do not suffice.
  • Situation Number 2 – Global economies are not that healthy, especially in Europe. Severe structural reforms are necessary in order to create real growth, not just financially engineered growth.

The primary conclusion then, is that you can stay long and grasp eventual price declines for rebound trades as central banks state that they will do whatever is necessary to keep things stable. In the longer term, as monetary policy is not working, watch out for the moment when somebody yells: “The emperor is naked.”



Euphoria & Denial Point to the Last Days of the Bull Market

  • Risks are cumulating and getting bigger.
  • U.S. GDP growth is slower than expected, earnings and oil prices continue to decline.
  • Japan is unable to grow while BREXIT risks are still unfolding.


It is difficult to find good news lately. The last really good news was the June jobs report when 287,000 jobs were added. Since then, most of the news seems dismal, however, it has yet to have a negative impact on financial markets. It’s as though investors are just hoping for something good to happen in the future. As hopes are an immaterial human feeling, they should not be the base for investment decisions.

In this article we are going to analyze what’s pushing the S&P 500 to new highs. Are we in a state of euphoria about stocks or are the valuations and price increases rational?

GDP News

The U.S. economy was expected to grow 2.5% in Q2 2016, but it only grew 1.2% (seasonally adjusted). U.S. economic growth for 2016 is currently at 1% which is the weakest start of a year since 2011. Saving the economy from a recession is consumer spending which increased by 4.2%.

Low interest rates create cheap money which fuels two trends, growth in both consumer spending and the S&P 500. Consumer loans have increased at a faster pace than consumer spending which makes it clear that spending growth is fueled by debt.

figure 1 consumer loans
Figure 1: Consumer loans at all commercial banks (blue) and consumer spending (green). Source: FRED.

Anyone who has studied economics will tell you that the economy works in credit cycles, when money is cheap and prospects good, people take on credit and spend it. But one can only take on so much credit, and all banks want their money back sooner or later. When sentiment shifts, a credit contraction arises and consumer spending falls. As this is inevitable, the only justification for the current hope of increased GDP growth can be explained with the most dangerous words for investors: “this time is different.”

figure 2 credit cycle
Figure 2: Credit cycle. Source: Loomis Sayles.

As we are in the expansion part of the credit cycle, a recession is going to hit us as soon as we reach the downturn part of the credit cycle because consumer loans are the only thing still boosting growth.

figure 3 gdp contributors
Figure 3: Contributions to Q2 economic growth. Source: Wall Street Journal.

If it wasn’t for consumer spending fueled by cheap loans, the U.S. economy would most likely already be in a recession.

The S&P 500

With economic growth largely missing expectations you would assume the S&P 500 would tank, but that’s not what happened Friday when the economic data was released. On the contrary, the S&P 500 reached a new intraday high at 2177 points. The main reason for the new S&P 500 high is hope of future economic growth, the same economic growth that didn’t realize itself in this quarter.

Another reason stocks have continued to rise has been the Q3 2016 expected corporate earnings growth, but that also vanished like the above described economic growth. As most companies have issued negative guidance we cannot expect higher earnings in Q3 2016.

figure 4 positive guidance
Figure 4: Q3 2016 earnings guidance for the S&P 500. Source: FACTSET.


It would appear the FED is also somewhat in denial about the true state of the U.S. economy and S&P 500 earnings, and is holding on to the hope of increasing interest rates as soon as the economy shows signs of strength, be we’ve been hearing the same story for a while now.

Last week the FED left the door open for interest rate increases as the economy seemed to be improving, but this was before Friday’s GDP debacle. With growth being lower than expected, the FED will probably continue with its status quo policy. As we now know that the only thing pushing the economy higher is consumer spending fueled by consumer debt, any interest rate increases would be detrimental for the economy and push it into the downturn part of the cycle because higher interest rates would increase the cost of debt.

Data on jobs, consumer spending and inflation will be available before the FED’s next meeting in September so we will closely watch that in order to see if the FED will eventually move, highly unlikely after the latest GDP debacle.

Global Situation

The BREXIT had only a short-term effect on markets as investors soon focused on other things and hoped that it would not have any long term effects. But any BREXIT effects won’t be seen in economic data for a few years as it will take the UK at least two years to exit the EU, if not four.

figure 5 brexit
Figure 5: Soon forgotten BREXIT. Source: Google.

News from Japan was also not that good. As economic targets have not been reached, the Bank of Japan decided to double the annual amount it uses to buy exchange traded funds, from ¥3 trillion to ¥6 trillion ($57 billion). This is only a modest increase to Japan’s easing policy, measured in hundreds of trillions, and brings us to the conclusion that Japan is out of monetary policy ammo. Even with constant increases in monetary easing, Japan has experienced a 0.5% deflation in June and slower consumer spending. This should be a warning sign for the U.S. as it is clear that easing has its limits.


All the above indicates that we are currently in the denial phase of a stock market cycle. We have had a bull market for 7 years now and no one wants to look at the above data as it indicates a turn in the credit cycle, lower business spending and earnings, a strong dollar and global uncertainties with the UK, Japan and China. We will analyze the situation in China soon as it requires a special article.

figure 6 stock market cycle
Figure 6: Stock market cycle. Source: The Gold and Oil Guy.

Not to mention oil prices coming close to $40 dollars per barrel, which will push energy earnings down, again.

All of the cumulating risks we’ve discussed send a strong message. Investors have to start thinking about risks and rewards. In the late stage of a bull market, many are overweight stocks, which means they can expect a beating if any of the above mentioned risks trigger a bear market. The options are to increase one’s cash in order to have liquidity when a market decline comes, or to own more uncorrelated asset classes. I’ve written more on this in our recent article on Ray Dalio’s strategy.

For stocks, simply ask yourself, how much are you willing to risk for a 4% long term expected yield?



Could the Economic Climate in Europe Be Contagious?

  • The first hard data after the BREXIT won’t be available until October, but property funds are already frozen.
  • The decline of the pound will lower UK GDP and will spill over into Europe.
  • Italian banks are in trouble as 25% of GDP are nonperforming loans.


As two weeks have passed since the BREXIT debacle, most heads have cooled off and we can calmly look at the current situation in Europe, the repercussions of BREXIT and contagion risks. It is important to analyze the full potential impact of the BREXIT by analyzing the stability of the European financial system, business investments, hiring and the political risk premium.

As BREXIT was popular primarily amongst the older population, politicians campaigned on a platform that promised that the money currently being spent on the EU would be diverted into the UK’s national healthcare system, the economic implications of which could be huge.

Situation in Europe

Europe could have done without this BREXIT vote as the last recession just ended in 2013 and the economic consequences will certainly have a detrimental effect on the growth experienced in the last two years.

figure 1 europe
Figure 1: European Union GDP annual growth rate. Source: Trading Economics.

We shouldn’t forget that the UK is still part of the EU and will remain so until all the administrative issues are resolved, presumably for the next two years or possibly even for the next four years. As GDP is always measured in dollars and the pound fell by about 10% in the last quarter in relation to the dollar, we can expect a decline in UK GDP (measured in dollars) similar to what was experienced when the UK left the European Exchange Rate Mechanism in 1992.

figure 2 UK gdp 1980s, 90s
Figure 2: UK GDP in the 1980, 90s. Source: Economics Help.

What saved the UK economy back then was a cut in interest rates, but as the current interest rate is 0.5%, not much can be done there. As the UK’s GDP is $2.8 trillion, it makes up about 15% of the EU economy, so a decline in the UK’s GDP will certainly have a detrimental effect on the EU GDP. An economic slowdown would make credit agencies downgrade the UK or possibly other countries in Europe and thus would create a domino effect of bad news. Moody’s has already expressed concerns about the BREXIT and stated that it will probably change its outlook for the UK from “stable” to “negative,” and Fitch predicts 2017 to be a record year for sovereign downgrades.

In addition to the impact on its currency, the UK economy will be hit by changes in the employment market as well. Some businesses will be forced to move their London branches to elsewhere in Europe. HSBC bank has announced that it will move 1,000 trading jobs to Paris, the same is true for Morgan Stanley, and let’s not forget that London is the European center for financial start-ups which will also have to be moved to somewhere in the EU to serve their primary markets.

The first impact the BREXIT has had is on UK real estate. $23 billion worth of assets in property funds have been frozen for withdrawals. Aberdeen Asset Management marked down the value of its UK property fund by 17% and suspended redemptions with an explanation that this will give time for investors to reconsider. The reality behind this funny explanation is that there is simply not enough liquidity behind the assets for redemptions. A halt in liquidity is also one thing to worry about in Europe.

We won’t know the full impact of the BREXIT for some time as most of the data won’t be published until after Q3 2016 is over. As the BEXIT repercussions become more clear throughout this year, some other risks will emerge as investors become more risk averse in this uncertain European political and economic time.

Italy and Its Banks

In uncertain times, investors look for safety and are much more risk averse. Some assets that were once not considered risky suddenly become risky. As investors withdraw their funds from the riskier assets, those assets consequently become even more risky as there is a lack of liquidity.

This is the situation with Italian banks. Not that Italian banks were ever considered that safe, but at this moment they might tip the stability of the European financial system. It is assumed that Italian banks sit on $401 billion of bad debt, equivalent to a quarter of the country’s GDP. For comparison, the percentage of U.S. nonperforming loans is 1.15% which is around $103 billion or 0.6% of U.S. GDP, thus 42 times less than in Italy which clearly implies that Italy is about to implode if the ECB does not intervene.

On top of Italy’s banking troubles, the country’s own prime minister certainly doesn’t know how to put a fire out. Instead of keeping things as calm as possible he immaturely attacks other EU banks stating that their derivatives exposure is a hundred times bigger problem than the Italian debt issue.

With the BREXIT and other populist leanings—including in Italy as evidenced by the statements by its Prime Minister mentioned above—the European markets should be terrible. In such a climate you’d think there would be plenty of bargains around, but the opposite is true.


All of the above may settle down, but the stock market in Europe is highly overvalued for such a political and financial mess. If you look at the iShares MSCI Italy Capped ETF (NYSEArca: EWI) it has a PE ratio of 12.79 but the biggest holdings are oil ENI which is losing money, highly indebted utilities ENEL and the biggest Italian bank Intesa San Paolo which will be in for a wild ride if a banking crisis hits Italy. Therefore, Italy and all other European companies are far overvalued for the potential risks.

figure 3 Europe PE
Figure 3: European PE ratios. Source: Star Capital.

It wouldn’t be a surprise if the above PE ratios are more than halved in the next year or two as a consequence of the BREXIT, which is just a symptom, and debt which is the real disease. As the ECB is buying corporate bonds on the open markets, even the ECB might be in trouble as there is nobody who can bail the ECB out.


The expected sovereign downgrades will push the dollar higher as global investors will seek safety which should negatively impact U.S. exports. Any kind of potential European crisis will bring turmoil to U.S. markets but investors can prepare for that by carefully assessing the situation in Europe.

Traders may want to seize the swings between bad news and ECB interventions, and long term traders might just want to short Europe as a weaker euro will make it easier to cover in dollars.

In general, we can expect uncertain times ahead of us. The last European financial crisis in 2012 with Greece as a culprit resulted in a European recession. The current situation doesn’t look much different, only this time Italy and the BREXIT will probably be the culprits.



Prepare for Earnings Season: Prices, BREXIT, GDP & Trends

  • This article provides a list of companies whose earnings will be affected by the BREXIT.
  • The dollar is stable thus we should not expect strong global currency effects.
  • The probability of U.S. recession has hit an 8-year high which should be detrimental for earnings in next two years.


In the long term, stock returns are perfectly correlated with the underlying earnings and therefore the upcoming Q2 2016 earnings season is very important. Positive earnings could push the markets to new highs while bad news could indicate the start of a recession or bear market.

In this article we are going to discuss how to prepare yourself by analyzing various factors that influence earnings.

Factors That Will Influence Earnings

To come to the best possible estimations, we are going to analyze commodity prices, currency swap rates and general economic trends.

Currency Effects

As more than 30% of S&P 500 revenues comes from abroad, currency translation effects are very important to analyze, especially now after the BREXIT.

figure 2 usd gbp
Figure 1: USD per 1 GBP in last 12 months. Source: XE.

The British pound has fallen 10% in relation to the dollar which means that all the assets, revenues and profits from the UK are now 10% lower than they were two weeks ago. This is the reality, but then there is accounting that will try to tell you various stories.

The impact on earnings will depend on the way a company accounts for its overseas assets and revenues. Companies that use the current rate method (i.e. the rate on the last date of the financial statement) will be immediately affected, while companies that use the temporal method (i.e. the historical rate at the date assets were bought) will not show the complete impact of the BREXIT in their statements.

Companies that get more than 15% of their revenues from the UK are Molson Coors (NYSE: TAP), BlackRock (NYSE: BLK), and eBay (NASDAQ: EBAY). Other companies that are also exposed are Apache Corporation (NYSE: APA), Transocean (NYSE: RIG) and ConocoPhillips (NYSE: COP) in the oil sector, and Invesco (NYSE: IVZ), E*Trade (NASDAQ: ETFC), Morgan Stanley (NYSE: MS) and Citigroup (NYSE: C) from the financial sector. Investors with those companies in their portfolio may want to check the accounting policies so they won’t be surprised by bad news in the upcoming financial reports.

All in all, the dollar index was even a bit weaker than in Q1 2016 and equal to its Q2 2016 level, so investors shouldn’t be worried about currency issues, with the exception of the UK exposed companies listed above.

figure 3 us dollar index
Figure 2: U.S. dollar index. Source: Bloomberg.


Average oil prices in Q2 2015 were around $60 per barrel while average oil prices in April 2016 were $37.86, May $43.21 and June $50, which is an average price of $43.69.

figure 1 oil prices
Figure 3: Average monthly oil prices. Source: Statista.

No matter the story presented by companies, trailing earnings will be severely hit and year-on-year comparisons will be negative as the price of the product they are selling is 28% lower than in Q2 2015. Long term investors should not be fooled by the growth in relation to Q1 2016 as oil prices are 50% higher, but traders can seize short term opportunities given by the positive short term trend.

Other Commodities

Gold stocks should see a nice boost to their earnings as gold prices have surged since March. Iron ore miners should also have positive news as iron prices were in the $55 to $60 trading range compared to the $40 to $45 in the two previous quarters. The same holds for copper, zinc and nickel prices.

In the fertilizer sector, prices continue to be around historic lows so investors should not expect a rebound. Ammonia prices are reaching new lows, and urea prices are at multi-year lows. The same is true for UAN prices and potash, but things might change in the next quarter as Canadian potash producers started to cut back on production.

General Earnings Trend 

The general earnings scorecard doesn’t look that good. S&P 500 earnings are expected to decline by 5.3%, and this decline will mark the fifth consecutive earnings decline.

figure 4 earnings and S&P 500
Figure 4: Earnings and S&P 500. Source: FACTSET.

As earnings have stopped growing, the S&P 500 has also stopped growing which only reinforces the theory that in the long term, stock returns are perfectly correlated to underlying earnings.

The 5-quarter decline in earnings growth suggests companies have reached their earnings limit in the normal economic cycle with low interest rates keeping asset prices high. In such an environment, bad earnings surprises are not uncommon and could have a negative impact on the market. Of the S&P 500 companies that issue guidance, 81 have issued negative guidance for Q2 2016 and only 32 positive EPS guidance.

The Economy and Longer Term Earnings Perspective (One Year)

The declining earnings indicate that companies have reached their earnings limit due to fierce competition. The artificial environment created by low interest rates makes everybody succeed and brings down margins. Even though no one likes it, a recession would be great as it would root out the weeds. According to Deutsche Bank, the probability of a recession in the U.S. in the next 12 months has hit highs not seen since 2008.

figure 5 us recession
Figure 5: Probability of U.S. recession in the next 12 months. Source: Deutsche Bank.

As earnings have been declining for 5 quarters, it is logical that investments will be lower which is exactly what is happening.

figure 6 business investments
Figure 6: Domestic business investments. Source: St. Louis FED.

Lower business investments should keep up earnings for a while but are detrimental to earnings in the long term.


The picture is pretty clear. Investors should focus on the geographical market of their respective investments and try to assess currency impacts before earnings are disclosed, especially for UK exposed companies.

In the long term, the high probability of a U.S. recession combined with 5 quarters of declining earnings indicates that the risks are higher than the rewards and investors should position themselves accordingly in the next two years.


Major Indicators Are All Positive, But Is It Time To Get Fearful?

  • Economic data is strong and positive.
  • Neither jobless claims nor consumer spending show signs of weakness.
  • The issues remain in valuations, optimism and low yields.


In the post-BREXIT world, there is a lot of speculation but no one knows what will happen. This article is going to provide a general outlook on how the economy is doing and try to extrapolate trends while ignoring the noise provided by the media.


As initial unemployment claims are reported on a weekly basis, the number can be used to forecast the monthly job report. On Friday the Bureau of Labor Statistics will release its job report for June. The previous report was scary with 38,000 jobs were added, but the number of initial unemployment insurance claims still remains at multi-year lows as well as the current unemployment rate, which sits at 4.7%.

figure 1 jobless claims
Figure 1: Initial unemployment insurance claims. Source: FRED.



figure 2 unemploment rate and claims
Figure 2: Unemployment rate and claims since 1990. Source: FRED.


By plotting the unemployment rate and claims we can see that the unemployment claims precede changes in the unemployment rate. Any increases in jobless claims are clues that there may be trouble brewing though the market may not recognize it yet. What’s most alarming about the above data is the impossibility for the unemployment rate to stay stable. As it is coming close to the natural unemployment rate, we should expect a trend shift in the coming years, though what we cannot know is if the unemployment rate will drop lower or if it will go up next month.

Consumer Spending

Consumer spending is growing and shows no indications of slowing down. A slowdown in consumer spending is also a leading indicator, and only after it begins to drop does it indicate trouble in the economy.

figure 3 consumer spending
Figure 3: Consumer spending and GDP. Source: FRED.


Similar to consumer spending, the consumer sentiment index is a great signal for forecasting a recession. The index hit its lows in the midst of 2008 while the deepest part of the recession was half a year later. It is now at its pre-recession highs, which would indicate there is no trouble for now.

Since consumer spending is still strong and consumer sentiment sits at its pre-recession highs, neither of these indicators point to trouble in the short term.

4 figure consumer sentiment index
Figure 4: Consumer Sentiment Index. Source: University of Michigan.



Inflation is tame compared to the 1980s, but it has picked up somewhat since the Great Recession indicating the economy is healthier.

Over the last 12 months, overall prices increased by 1%. Energy prices are at multi-year lows and favorable weather conditions have brought high crop yields which lowered food prices, therefore 1% inflation rate should be considered very good.

figure 4 consumer price index
Figure 5: Consumer price index (1984 = 100). Source: FRED.


Issues With The Above Data

With all of the favorable data, it might be tempting to pay higher prices for riskier assets, but that is exactly the biggest trap such economic indicators create.

A closer look at the above data shows that current indicator levels are similar to those from 2007, so even though they are all positive it might not be the best time to be heavily invested. Keeping in mind the essential investing quote of “being greedy when other are fearful and being fearful when others are greedy,” this might be the time to be fearful and wait for a future recession to be greedy.

figure 6 sandp gdp
Figure 6: S&P 500 and GDP since 2007. Source: Yahoo.


The market is far more volatile than the economy because investors tend to be overoptimistic in good economic times—as is the case now—and overly pessimistic in a recession. As all indicators are at their best levels, it is time to be fearful.

The issue here is that this is contrary to human nature as we are social creatures. Doing things differently than the rest of the pack makes us very emotional, but investors have to learn how to set emotions aside as markets and money have no emotions.


Except for the fact that the market is finding it very difficult to grow and all economic indicators are more likely to worsen than improve in the next few years, another important indicator—which is the result of the positive economic developments—are valuations. Simply put, relatively high valuations increase the risk of holding stocks and minimize long term returns.

With 7 years of positive economic developments, investors should carefully analyze growth and clearly separate the growth coming from the general high liquidity artificially created by the FED, and real business qualities. A good way to do that is to look at debt levels. If revenues increase slower than a company’s debt level it means that the return on capital is lower than the cost of capital. Such a situation can be sustainable in an economic growth cycle but comes to an abrupt end at the first signs of a recession.


One has the be foolish to look only at the positive economic indicators and assume that everything is good and being long stocks is the best option. Stocks will be the first to react if any of the forecasting economic indicators turn negative, so careful stock selection is the only option to preserve capital in these uncertain times. Other risks come from exuberant optimism which inflates asset prices as well as low yields, which pushes investors toward stocks in search of higher yield, but which also comes with higher risk.

As we do not know when the economic winds will change, the current market volatility gives great opportunities to increase portfolio returns with well placed trades and a more active investing strategy.


How to Prepare Your Portfolio For The Next Recession or Stock Market Crash

  • The risks of a slowdown are higher than the upside.
  • Fundamental trends are negative in advanced economies while emerging markets show higher growth rates and are cheaper.
  • It is important to create a diversified portfolio with uncorrelated assets.


In an environment where it seems maximum potential for the U.S. economy has been reached, the St. Louis FED chief, James Bullard, has said in his most recent report that he favors only one interest rate increase through 2018, which would at best keep things stable. His view is further supported by the fact that the unemployment rate is sitting at below 5%, and the Personal Consumption Expenditures PCE inflation—measured by the Dallas FED—is at 1.84%, both of which signal that the economy has reached its maximum potential.

1 figure trimmed inflation
Figure 1: Trimmed mean PCE inflation. Source: FRED.

The scary part of the report is where Mr. Bullard describes how forecasts are made based on the current situation, which will most definitely change. What is difficult to predict is the direction of the change therefore, forecasts are bound to be incorrect and under the influence of various risks like a return to the normal Phillips curve influence where low unemployment triggers inflation, or a recession even if no current data indicates the possibility of one. Thus only an extremely positive scenario would trigger interest rate increases if fundamentals like inflation or productivity stay stable.

2 figure fed stlouis
Figure 2: St. Louis FED’s U.S. macroeconomic outlook. Source: St. Louis FED.

The conclusion is that practically anything can happen, and the FED has absolutely no idea as to where the economy will be in a year or two. Even FED Chairwoman Yellen admits that the 2013 expected interest rates of 4% for 2016 were too high and that an aging society and a slump in productivity growth will keep the subdued economic indicators persistent.

In such an uncertain environment, an investor should look at the best ways to protect his downside and maximize his upside.

Investment Ideas

Let us start with bonds where interest rates have been declining since the start of this century.


3 figure bonds
Figure 3: 10-year government bonds yields. Source: Wall Street Journal.

As bond prices are inverse to bond yields, any increase in yields would precipitate bond prices, thus bonds are currently low yield and high risk. Usually considered safe havens in recession times, bonds currently do not provide such protection as it is better to keep cash than bonds with negative interest rates. There is the option of further bond price increases, but that is a highly unlikely scenario as bond yields are at historical lows.

The Stock Market

The S&P 500 is still holding well, but does not manage to break the previous highs despite having come close several times.

4 figure s&P 500
Figure 4: S&P 500 in the last 12 months. Source: Bloomberg.

The S&P 500 dividend yield is 2.12% which might look tempting when compared to the extremely low bond yields, but it is meagre when compared to the historical mean of 4.39%. A return to the mean would result in a drop of 50% or more of the S&P 500 index. The conclusion here is the same as with bonds: High risk, low returns.

But there is an option with stocks that should limit the downside. Dividend stocks that will not see their cash flows affected by a slowing down in the economy are always assets toward which investors run when trouble comes. Examples can be found in telecommunication, consumer staples and healthcare.

Emerging Markets

If the reason for economic stagnation in the developed world is an aging society, slow productivity growth and emerging markets competition, a contrarian thesis would be to invest into emerging markets.

Emerging markets have a relatively young population and are currently shunned by investors as too risky amidst a commodity price slump. But no matter the current issues, the World Bank expects emerging markets and developing economies to grow at rates north of 4% in the long term, while advanced economies are expected to grow below 2%.

Currently, advanced economies are preferred by investors as they regard them as secure, but long term structural trends are strong in place even if we do not choose to see them. What China has done in the last 15 years could be the same as India is about to do. Brazil will probably also return to growth someday.

The following figure will show that the current developed world impression of asset security is mostly funded by debt which is unsustainable in the long term.

figure 5 investment position
Figure 5: U.S. net international investment position. Source: Bureau of Economic Analysis.

On top of that, emerging markets are much cheaper than developed ones according to the Cyclically Adjusted Price Earnings (CAPE) ratio which takes into account earnings from the past 10 years.

figure 6 global cape
Figure 6: Global CAPE map. Source: Star Capital.

For long term investors, the less risky option might be to dig for good investments in emerging markets with positive demographics and a strong growth outlook. Currently those investments are out of favor, but this is exactly the environment where investments give the best returns.


Gold is a doomsday investment, it protects you against inflation and is the metal that surges in difficult times. Typically as the economy does well, stocks grow and gold declines because gold has no yield. The opposite happens in turmoil.

7 figure guardian precious metals
Figure 7: Gold and stocks cycle. Source: Guardian Precious Metals.

You can invest in gold by buying it physically, through ETFs or by buying gold miner stocks.


As always, good diversification should provide sufficient downside protection but a portfolio has to be diversified with uncorrelated assets.

If you have Ford in your portfolio and then you add some Caterpillar, that is not real diversification. Gold, emerging markets, cash, and quality stocks should enable a portfolio to weather economic hardships.

Don’t forget that after every recession comes a recovery, so be ready to increase your exposure to stocks when assets are cheap, even if everyone will be thinking that there is no tomorrow.


Is Global Recession On Its Way? Brexit May Be A Warning Sign…

  • Global GDP growth rates are stalling even with increased monetary stimulus.
  • There are several potential recession triggers.
  • It is important to assess the risks a portfolio runs as no one can know when a recession will come, but eventually it will as it always has.


The main FED goals are sustainable economic growth and full employment. In order to achieve those goals, the FED has decided not to increase interest rates as the economy is still relatively weak and employment has been slowing down. Not only that, but the expectation of future interest rate increases has been revised downwards.

This brings several consequences. In case of an economic downturn, which would be completely normal as we have not had one in the last 7 years, the FED has no maneuvering space left to help the economy as the interest rates are still at recession levels.

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Figure 1: U.S. GDP growth to date. Source: Multpl.

As the last recession was 7 years ago and every economy is cyclical, we should not be surprised if a recession comes along. No one can know when this will happen as recessions always come unannounced, but we can take a look at the risks that can trigger a recession and the consequences of it.

Potential Recession Triggers


A vote in favor of the U.K. to leave the EU might influence some longer term market disruptions as London is the European financial center. The U.S. Treasury Secretary recently issued a warning stating that the global economy would be damaged if the U.K. leaves. The recent polls show a scary shift toward a leave.

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Figure 2: Brexit polls. Source: Financial Times.

The ‘remain’ has always been greater than the ‘leave,’ but it seems that the undecided are turning toward a leave. Next week will be an interesting one as we will see the long awaited Brexit vote confirmed, be it a leave or a remain.

Another Bad Summer in China

Last summer we had the first meaningful stock market fall in the last 7 years as the Chinese stock market precipitated on weaker Chinese growth.

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Figure 3: Chinese GDP growth per quarter. Source: Trading Economics.

As China is increasing its debt levels in order to force economic growth, the long term perspective is one where if all goes well, China will have stable growth levels but any global shock like the above Brexit might influence further slowing down and a global deflation spiral.

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Figure 4: Chinese debt to GDP. Source: Trading Economics.

Debt usually means trying to hold on to the status quo until there is liquidity. The above increases in Chinese GDP show that China is desperate to keep its growth rates as it might implode without high growth rates.

As China and all other economies are dependent on global trading, any indication of global isolation would quickly spur discomfort into the market and this brings us to the next possible trigger.

U.S. Isolationist Tones

Currently Clinton is ahead in the polls but the Brexit example shows how we cannot bet on polls. If Trump’s isolationist rhetoric is more than just election tactics this could have a severe impact on U.S. trade and global economics. History has proved that any kind of isolation is detrimental to economic growth and wellbeing, and the current high standard we are enjoying is a result of global integration increasing its speed in the last three decades.

Global Monetary Policies Imbalances

With the FED slowing down, this is less of a concern as the higher U.S. interest rates would have strengthened the dollar and lowered U.S. exports. Everything produced in the U.S. would have been more expensive and U.S. corporate earnings would have been lower in dollar amounts.

Countries like India or Brazil, where interest rates are relatively high, are still not such a big influence on the global economy, but an economic rebound or inflationary pressure in one of the global economic pillars like Europe or the U.S. would trigger worldwide financial instability.

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Figure 5: Global interest rates are at historical minimums. Source: Trading Economics.

The event of such a situation is highly unlikely especially after the FED has slowed down with its interest rate plans and the situation in Europe is not indicating economic exuberance.


Europe is the next risk factor for global markets. Even if we haven’t had a ‘Greek’ moment or a bank crisis for a while as the European economy is growing, that growth is still not stellar and has already peaked.

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Figure 6: European GDP growth. Source: Trading Economics.

EU growth has reached 2% in 2015 but is already declining and sits at 1.8% currently. This is a good number for Europe as the 2012/2013 recession is not far away, but the growth is fueled by increased debt levels and the non-performing debt ratios are scary for EU banks.

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Figure 7: Non-performing debt ratios for EU banks. Source: European Central Bank.

For comparison, the average U.S. non-performing loans are at 1.67% which is much lower than the EU 7%.

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Figure 8: U.S. non-performing loans. Source: Statista.

Therefore, Europe not only has the ‘Brexit’ issue as a potential destabilizer but also bank fragility and the fragility of the whole economy.

Understanding of Risk

The last risk related to global markets is the assessment of risk investors have. With yields at historical lows, investors might be losing the perception of risk, especially as central banks run to save the markets as soon as any decline is anticipated.

A shift in the perception of risk might be the biggest risk of all as we have seen that after the FED decided to keep rates steady and lower for a longer period of time, the DOW index declined and did not, as usual, increase based on continued FED stimulus.


The scope of this article is not to be the chicken little but to objectively assess real risks to your portfolio. A recession would be catastrophic at this moment as central banks are out of firepower. Maybe they can keep markets at a permanent high level with low interest rates, but there are several structural and cyclical longer term forces that come into play here and cannot be influenced by monetary policy.

The U.S. is approaching full employment, corporate earnings and investments have been declining for a while even though interest rates are still low. As we already mentioned, we cannot know when any of the above described risks will kick in, maybe even next week with Brexit, or not in the next few years.

Eventually a recession will come, as it always does, unannounced and surprising, nobody knows when but it is good to think of how risky is your portfolio in relation to that and if maybe the same returns can be reached with less risk.