During the bull market phase of this longer term secular bear market, which I will readily admit has gone further and faster than I anticipated, market participants have fallen trap to the idea that the normal business cycle has been repealed. This could not be further from the truth.
In fact, during balance sheet recessions as we are in now, and unfortunately only have one other period in history to draw conclusions from, business cycles from trough to recovery to decline, occur in a faster time span than what we have witnessed in post-WWII business cycle recessions.
The explanation for this is that during post-WWII recessions total credit market debt to GDP averaged about 150% – therefore, this allowed businesses and consumers alike the ability to take on a modest amount of leverage to help make ends meet when the economic cycle got weak. As the cycle recovered, the household then reduced some of the leverage that was taken on. However, at the peak of the economic cycle in 1929 – total credit market debt to GDP reached 270% and quickly fell during the economic depression. This was due to the complete failure of the financial system at the time, the lack of access to credit, and a complete retraction of the consumer. Today, that total credit market debt to GDP ratio is over 350%. Therefore, if the current economic cycle slows, as reflected in the falloff of GDP in the most recent 1st Quarter report from 3.1% to 1.8% – consumers do not have the ability to take on additional debt to weather economic weakness. In fact, today, it is quite the opposite as individuals and small businesses alike are in a process of getting rid of debt, versus taking more on, which has shown up in a sharp decline in money velocity.
So, what does all this have to do with the current business cycle? The recent release of the ISM numbers are flashing that the highs for this current business cycle expansion, fueled primarily by fiscal stimulus, may be in. While GDP showed a sharp contraction in the first quarter this also showed up in the recent release of the ISM Index and as already foreshadowed by the strong downturn from recent peak in the Non-manufacturing index.
While this by NO means implies that a recession is quickly approaching around the corner – what it does elude to is that the current cycle is slowing and that will impact profit margins, particularly as input prices continue to rise, and ultimately this will lead to lower stock market prices.
Stocks are currently priced for continued economic acceleration and if our forecast of a sub-2% 2nd Quarter GDP comes to fruition this could spell some mid-year troubles for stock prices.