The Oil Shock Recession is Now Inevitable
By Dennis Slothower
Editor, Stealth Stocks
For the last several months, I’ve talked about what will happen to the economy when oil prices move higher. Since February, when oil prices moved above $85 per barrel, I’ve been telling investors how the economy would contract in spite of Wall Street’s rosy 4% growth predictions.
You likely know by now that the 2Q11 GDP figures came in at 1.3%, but as the Fed acknowledges, this estimate is incomplete. The government sharply lowered the 1Q11 GDP from 1.92%, reported on April 28, to just 0.4%!
What this means is that we likely can expect another adjustment to the downside in August, which would push the GDP into negative territory for the second quarter. What’s more, we learned that real personal consumption expenditures plummeted to just 0.1% in the second quarter, compared to 2.1% in the first. Durable goods decreased 4.4%, in contrast to an increase of 11.7% in the first quarter.
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According to the most recent Fed beige book, economic activity in eight of twelve regions is markedly slowing, which the Fed largely blames on droughts, flooding and still-lean inventories due to the Japanese supply-chain disruptions.
Wall Street economists want us to believe this is only a “soft patch”—a period of slow growth, short of a recession, with the economy hovering just above a contractive state—and that once we work through the natural disasters, the economy will recover in the second half of the year. C’mon…do they think we would really believe that?
Brent crude oil averaged north of $115 a barrel in the month of July, which crushed the global economy. And this summer’s high gasoline and food prices have already fractured the economy. It will become more obvious in the third and fourth quarters how much damage QE2 has really caused.
The trend I’m seeing—a deceleration in the slope of almost all the economic charts—doesn’t suggest just a soft patch, but a fractured economy just beginning to feel the effects of extreme commodity prices. Currently, I’m seeing demand for factory goods contracting. June’s durable goods was a very disappointing -2.1%, on expectations of an increase of 0.3% from 1.9% in May.
Manufacturing in many regions is slipping into recessionary territory, with the Empire Manufacturing Index at -3.76. The Federal Reserve Bank of Philadelphia’s July report came in at 3.2. The Dallas General Business Activity Index improved in July from -17.5 to -2, but anything below zero is considered recessionary. The Richmond Fed Index fell from 3 in June to -1 in July.
The Chicago Purchasing Managers Index slipped from 61.1 in June to 58.5 in July. The PMI Employment Index printed far lower, from 58.7 to 51.5, even as prices paid increased (inflation) from 70.5 to 71.7, while new orders declined from 61.2 to 59.4. Also, the Chicago Fed National Activity Index is just a sliver above 35. A drop below 35 is a precursor to recession. I think you get the picture.
What Should You Do Next?
Let review a few things. In February when crude oil prices rose above $85 a barrel I warned the stock market was moving into oil shock recession territory. At that time I had you in commodity positions, but the positions began to lose momentum and we were forced to the sidelines.
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Market breadth began to erode more forcefully with fewer and fewer stocks holding up the market and the stock market began to whip saw. My advice was to stay out of the market, warning you of a broad market top, transitioning into a double dip recession.
The Fed recently explained that it intends to keep interest rates at zero for two years (indefinitely) but it added a new line to its statement, a very key line.
“The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.”
On August 26th, Ben Bernanke spoke at the annual Jackson Hole, Wyoming Fed conference. Rather than launch a real “shock-and-awe” stimulus program, Bernanke is keeping his cards close for the time being.
Bernanke reasoned that the long-term growth picture for the United States remains strong. But he conceded that “the economic healing will take a while, and there may be setbacks along the way.”
Those setbacks could include another major wave down which could send the S&P 500 plummeting down to the 600 range before the next bear market cycle bottoms.
The speed of this market is mind numbing, like the crap tables of Las Vegas with you betting against the house. Shorting the stock market may seem the most sensible thing to do but remember – right now the market could move 10% in either direction on the drop of a dime.
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