You heard it here first, folks. I am predicting the US economy will be in recession by the end of this year.
We are at the beginning of a textbook Keynesian contraction. Moderate growth combined with contractionary monetary policy and now, with the new Bush budget, contractionary fiscal policy. The labor market is weak as evidenced by the steep decline in the labor force participation rate and declining real wages. In fact, as of January, the participation rate in the labor force of men is the lowest it has ever been since records began in 1948. Workers are finding few options in the job market just as investors are finding few options in the capital markets. Which leads us to:
The flattening yield curve. The yield curve shows bond maturities on the x-axis and interest rates on the y-axis. For the best picture of it on the web go to www.stockcharts.com. On the left side click on "Dynamic Yield Curve". You can see the movement of the yield curve over the last few years. (I am in no way affiliated with the stockcharts website). What you will see is that the yield curve provides Adam Smith's "Invisible Hand's" view of future economic growth. An upward sloping curve predicts growth and a flat or downward sloping curve predicts recession. The yield curve has been flattening at a rapid rate.
The Fed has been raising short-term rates to get them above the record low levels of the past few years. Normally, the market would push long-term rates up with short-term rates. However, the market does not foresee the same economic growth the Fed does. The market is actually pushing down long-term rates. It is not truly flat yet but the momentum has all the indication of a move to recession.
For investors:
-Pay down your debt. Eliminate variable rate debt in favor of fixed rate debt in case the recession causes a credit crunch and a sharp temporary rise in interest rates.
-Move stocks to consumer staples and large companies
-Overweight cash, but do not leave the market entirely
-Overweight foreign securities to take advantage of continued dollar declines (this is good strategy whether recession happens or not)
-In most recessions you would want to move to bonds, but bonds are already very expensive. Overweight short-term bonds as a principle preservation strategy instead of higher returning strategies with long-term bonds.