Wasington, D.C. -- (ReleaseWire) -- 04/24/2015 --Last Friday, the Dow had a dump of 420 points off its high, closing down 279.47 points, which was 1.54 percent. This was, simply, a technical breakdown of the Dow, and a clear indication that there is something absolutely not right about the economy. I believe that we are either re-entering, or have already re-entered the recession that refuses to die. Other signs abound, as well, including weaker than expected March headline job numbers and weeks, if not months, of poor fundamental indicators which have led to a decrease in the growth of U.S. GDP.
Many say that this cannot be a recession because one of the traditional signs, an inverted bond yield curve, hasn't appeared. In a normal yield curve, yields on Treasury bonds are lower for short-term bonds than long-term bonds, because investors generally expect less return when their money is tied up for a shorter period of time. When investors have low confidence in the economy's near-future prospects, though, they are willing to hold longer term bonds even when yields are low. This inverted yield curve may not be the recession indicator it once was, however, because years of Keynesian policies from the Fed have divorced the markets from the basics. In fact, the two-year and ten-year Treasury bonds, which are normally strongly correlated in terms of yield, have become almost completely anti-correlated. This collapse of the yield curve's internal relationship seems to predict that the myth of a strong US economy driving up short term rates really is just a myth. Reality is showing up more and more, in global pockets of deflation and inflation and liquidity squeezes. Coupled with increasing debt saturation weighing on economic growth prospects in the U.S. and around the world, there are clear signs that something bad is on the horizon. Can you handle it?
Last week, the St. Louis Federal Reserve released a rather amazingly smart report in which they strip out deferment and forbearance from the denominator of the student loan delinquency rate equation, so everyone could get a better idea of what the real numbers look like. It turns out that, right now, only 55% of student loans are actually in repayment, and 27% of those are delinquent. It makes sense to assume that a similar percentage of the remaining 45% of student loans will wind up in delinquency once they are required to begin repayment, unless something changes in the economy. This means that, in all likelihood, nearly one in three student loan borrowers are going to wind up more than 30 days delinquent, and that adds up to about 400 billion in student debt.
This matters to investors because that debt winds up getting packaged and sold in the form of asset backed security bonds. In fact, on April 8th, Moody's Investors Services announced that they had placed on review for downgrade the ratings of 14 tranches in 14 securitizations backed by student loans originated under the Federal Family Education Loan Program (FFELP). That's $3 billion of student loan backed ABS on watch for downgrade, based on the strong possibility of default. Investors should be aware of how this, and the ripple effects, will affect their portfolios, and act to protect themselves.
Debt is an issue not just in the United States, of course. In fact, the IMF recently warned regulators (not investors, mind you—regulators) to prepare for a global liquidity shock, and on the same day, the Chinese announced a ban on certain sorts of financing for margin trades on over-the-counter stocks, a behind-the-scenes preparation of their own for the same scenario. We are beginning to see similar preparations in Europe as they fearfully anticipate Greek debt default or exit from the Euro zone. In the United States, we have just witnessed the biggest spike in credit application rejections ever recorded. Credit conditions are tightening, and once the liquidity squeeze begins, it creates the sort of fear that gives the impetus for market selloffs. Perhaps last Friday's dump in the DOW was in part a reaction to this. Are you ready to handle it?
If we are back in the clutches of this undying recession, state finances are in no position to weather it. States are still recovering from the 2008 recession, even after six years of supposed economic growth. According to a recent stress test of state finances conducted by Moody's Analytics, states would need to cut spending or increase revenues by a combined total of $21 billion in the event of a recession, further exacerbating economic weakness. State reserves stand at around half of what they were prior to the last recession, with New Jersey, Pennsylvania, Illinois and Arkansas at the very bottom of the savings list. According to Pew Research, New Jersey, for instance, has only 3.3 days worth of cash, or 0.9 percent of 2014 budgeted spending, on hand. Compare that with Moody's estimate that an average state would need 8.5 percent of budgeted spending on hand to survive a year of recession without increasing revenues or cutting spending. Even the White House took note and issued an atypical warning: "What the Great Recession has shown is that things have fundamentally changed and that states need to be very much more prepared for volatile fiscal conditions." Simply put, the states are not, which means that any recession will be followed by the additional shock of unprepared states cutting spending or raising taxes. Tax collections are already experiencing major swings, because people simply don't have the money to pay. Most states simply don't have the planning or the resources to handle a recession. Do you?
So, as an investor, how should you be preparing for the return of the great recession that just won't quit? Think about your own rainy-day fund. We're seeing the beginning of a liquidity squeeze, with the flow of credit tightening. Global economic activity will start to slow down. This happened during the last crisis, and during the next one it will be even worse, so it's important to have an emergency fund, and start thinking about it now. In a crisis, liquidity is of paramount importance, not just for the sake of peace of mind, but in order to take advantage of opportunities that present themselves. You can handle this, with some planning and caution.
All data sourced through Bloomberg
Securities offered through Western International Securities, Inc., Member FINRA & SIPC. Bennett Group Financial & Western International Securities, Inc. are separate and unaffiliated companies.
About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett or dbennett@bennettgroupfinancial.com