The U.S. Is Entering a Recession Right Now; Here's Why

If this post didn't make you think I was crazy - or this one - today's likely will.

Despite the new highs and the great growth and yada yada yada... we are on the brink of a recession. I have the numbers to prove it.

And the numbers don't lie.

Data on federal tax collections comes to us in real time every day, courtesy of the U.S. Treasury. This is unmassaged real data, not the endlessly finagled economic data put out by various other U.S. government agencies. Tracking the tax data regularly enables us to see how the U.S. economy is actually behaving versus how the government wants you to think it's behaving.

That's important because the current data tells us something really big about the U.S. economy that nobody knows yet. It won't show up in the official GDP data for months, but it could rock the markets and cause the Fed to change course.

Here's the big news.

Nobody Is Looking at These Tax Numbers - and the Drop Will Catch Them Flat-Footed

Withholding tax collections plunged in the second half of November, suggesting that the United States is on the brink of, if not entering, recession.

The drop in withholding not only broke a yearlong uptrend, but it has established a downtrend. After adjusting for wage inflation, the year-to-year comparison is now slightly negative. It means that the United States is barely hanging above recession. It will take a couple of months more before we know for sure one way or the other, depending on how strong or weak collections are.

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Officially it takes two quarters in a row of falling GDP for the NBER to call a recession. By the time that second GDP report comes out, months after the tax data has already tipped us off, the recession will have already been under way for seven to nine months. But the Fed wouldn't materially loosen policy until then.

There's no guarantee that the numbers will go negative in the short run. Consequently, we should not expect any loosening of policy until at least late 2018. That's plenty of time for tight monetary policy, euphemistically named "normalization," to cause considerable damage to stock prices.

The Fed started real tightening in October. It has begun to shrink its balance sheet. That will pull money out of the banking system. The program is starting very gradually, with only baby steps that are barely impacting the markets. But over time, it will increasingly drain money from the pool of cash available to purchase stocks and bonds. This has set up the conditions for a bearish stock market, but as I have been emphasizing, it won't necessarily trigger them immediately. As you know if you have been following along with these reports, we've been looking to January or February as the likely window for a market high.

Because the tax data is real-time hard data, it gives us an edge. Economic data is lagged and manipulated. It often takes another month, or several months, before the economic data reflects what the tax data has already shown. With the benefit of knowing what the tax data tells us about the actual state of the economy, we can move in advance of the crowd. We can more easily identify the false narrative, or at least the old narrative that is no longer true.

The strength in the tax data prior to November told us that the economy was heating up. That told us that the Fed would tighten. These cycles tend to last a few years. During that time, the Fed has difficulty because the economy defies conventional wisdom and continues to heat up as interest rates rise. Bear markets thrive in these environments. Each time the market sells off, the bottom is declared and dip buyers come in. But the ensuing rally falls short of the last one and the market rolls over again.

Early in the cycle the opportunity usually presents itself to place judicious short positions on both individual industries and the broad market. I give suggestions for those based on technical analysis in the Wall Street Examiner Pro Trader Daily Trades List.

The Chart That Shows Me We're in Recession Territory

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Total withholding tax collections are available to us virtually in real time in the U.S. Treasury's Daily Treasury Statements, released with just a one-day lag, which makes them an excellent analytical resource. However, they are extremely volatile day to day, so I rely more on a monthly moving average of the 11-day total collections, comparing that with the prior year. Smoothing sacrifices a bit of timeliness to get a clearer picture of the trend without losing too much of the edge that the daily data provides. Unfortunately, I have found even the 11-day total data too noisy for meaningful comparison, so I've had to resort to additional smoothing. As a result, the smoothed data is a little slow, so I also look at raw data trends to get a better sense of timing.

Withholding tax collections are now signaling that the U.S. economy is on the cusp of possible recession. The annual growth rate slipped to 2.2% as of Dec. 5. That's before inflation. Average weekly earnings have lately been growing at somewhat north of 2.5% (but there's no inflation, ahem). So applying a 2.5% wage inflation factor indicates that real growth is now slightly negative.

Do that two quarters in a row and it would be an official recession. The Fed wouldn't loosen policy until at least then and possibly later. Furthermore, there's no guarantee that the numbers will go negative in the short run. Consequently, we should not expect any loosening of liquidity probably until at least October, and maybe later.

This weakening in withholding tax collections followed two very strong months in September and October where they were gaining around 8% to 9% on a year-to-year basis. At the same time, we were seeing canaries in the coal mine in other tax series, particularly excise taxes, that told us that there was something rotten going on. This supports one of my pet sayings: "Employers are always the last to get the news" - along with investors!

The big gains over the summer were probably more about huge gains in withholding from those at the very top of the income spectrum and not about broad based recovery. Big percentage gains by those earning millions skew the top-line totals to obscure weak gains, if any, in the middle of the spectrum.

That's bearish because it keeps the Fed on its tightening course. Markets top out when the economic news is good because that's when central banks pull the punchbowl. That process is under way again. We already know what the outcome will be. It is only a matter of time.

Your Mission: Raise a Substantial Cash Position by January

The first point at which the Fed would probably consider easing or reversing tight monetary policy is still a long way off. That's true even if the first hints of recession we see in the tax data prove to be the beginning of a persistent trend. The Fed will keep tightening until well beyond the point where the economy has begun weakening. If the recession starts now, we probably won't see easing until the third quarter of next year.

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If this little dip in tax collections turns out to have just been a blip, and the economy continues growing at a modest clip, count on the Fed to keep tightening until the stock market has a very bad accident. Only it won't be an accident. These things happen when the Fed tightens. It believes that it can manage the economy's glide path into a soft landing. That's rarely the case, particularly with the buildup of massive excesses of leverage and speculation in today's markets.

This data gives us every reason to stay the course in a program of regular sales of small amounts of stock, with the goal of raising a substantial cash position by January, or March at the latest for anyone who get a late start. I'd be shooting for 60% to 70% cash by that time. Your goal may vary depending on your personal circumstances. But a substantial cash cushion will come in handy next year to protect against a market decline and to provide the wherewithal to pick up bargains when the market does decline.

As for short selling, the time may be at hand to start nibbling at shorting the SPY or other market-based ETFs. I would initially and gradually take small short positions as a hedge. I would not use leverage at this point, as my technical work shows that there's still upside risk in the near term.

Likewise with buying puts, where timing is even more critical. For that, I'd wait for the first clear signs that the back of the uptrend had been broken. If you are a short-term trader looking for specific trades, check out my Daily Trades List at the Wall Street Examiner.

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The post The U.S. Is Entering a Recession Right Now; Here's Why appeared first on Lee Adler's Sure Money.

About the Author

Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.

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