Bonds are Forecasting a 2007 Recession

By: Robert McHugh | Sat, Feb 17, 2007
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We believe the intermediate-term risks in Bonds have moved away from a decline to a rise in prices, and declining long-term interest rates. This is frightening, as it means we are about to enter another recession, one that could be deeper than we have seen in a long time. Why do we see this as an increasing risk?

Primarily what has changed is the development of a Symmetrical or hybrid Ascending Bullish triangle from 2002, shown above, and below as a close-up. Triangles are usually wave fours, so that means we have a wave five up coming after this pattern completes. Whether this pattern is a Symmetrical Triangle or is an Ascending Triangle, both are Bullish for prices. In the case of a Symmetrical, the trend leading into the triangle is the trend that will continue after it completes -- in this case up. In the case of Ascending, they are almost always Bullish.

Above we show the long-term Elliott Wave labeling from 1982 when bonds bottomed, ending a century long decline in prices, perhaps of Supercycle degree. Perhaps the above labeling is one degree too low, that the Intermediate labels should be primary degree, that the minor degree labels should be intermediate degree. However, the point is, once this triangle finishes, a major rally in Bonds should unfold, higher than we saw in 2000, which means long-term interest rates could approach 1 or 2 percent, which suggests a major recession or even depression is coming. If so, look for a devaluation of the Dollar to deal with the coming debt crisis.

Timing? It looks to us like wave d up has topped. Bonds should now decline into the final wave e down through the spring/summer of 2007. Then we should see wave 5 up, and the recession as well. We have a steepened, inverted yield curve, which often predicts recessions, so it all fits.

Short-term, before the mega-rally starts in Bonds, Intermediate wave 4 must first bottom. Minuette wave b up is about over, and next is a fairly sharp decline to around 106ish, wave c of e of 4.

There is a Head & Shoulders Top in formation, not yet confirmed, but looking textbook, that supports a decline into the 106-ish area over the next several weeks and months. The timing is interesting as a sharp drop in Bonds here will unnerve stock and housing markets over the next several months. This should trigger the coming recession, which will in turn force the Fed to buy Bonds with the same fervor it sends its regulators in after bankers. Spending a ton of freshly printed electronic money, the Fed must drive interest rates much lower in the second half of 2007. That flood of fresh money during the coming recession will devalue the Dollar sharply.

The technical landscape pointing toward a 2007 recession is supported by the economic reports. Here's the dour news from this week:

Industrial Output fell 0.5 percent in January, with the manufacturing component dropping 0.7 percent, mostly related to motor vehicles, according to the Federal Reserve. This was the largest decline in 16 months. The Philadelphia Fed reported that its Business Activity Index for the Mid- Atlantic region fell to 0.6 in February from 8.3 in January.

Housing Starts plunged 14.3 percent in January, to the slowest pace in over 9 years, since 1997, according to the Census Bureau. This was 22 percent below the 2006 monthly average. New Single Family Home Permits fell 4.0 percent in January, a six year low. This is just the building side. We have 1.5 million adjustable rate mortgages scheduled to reset significantly higher this year; foreclosures are up; and prices (loan collateral) are down.

According to the National Association of Realtors, Housing Prices fell 2.7 percent in the fourth quarter 2006 versus the same period in 2005, the largest year over year decline ever. Second homes are getting killed, many vacation areas showing price drops of 20 percent.

Mortgage applications rose 1.5 percent in the latest reporting week. But those are apps. Let's see how many loans close given the sub-prime lender problems and declining prices (appraisal values). There's only one way out of this mess: sacrificing the dollar. A planned hyperinflation of the money supply and devaluation of the dollar will assure that markets rise in nominal prices, a necessity given the debt crisis that is looming. There is simply an imbalance between income and debt service, and if asset valuations are permitted to decline, the result will be economic chaos. There is no choice here for the Fed. They must print and get that money into as many consumer hands as possible. They must lift market prices higher -- buy bonds (and ergo stimulate housing) and stocks; and raise cash for increased entitlement payments -- put cash directly into the hands of consumers. The Fed must pretend to be inflation vigilant, while doubling the money supply. This is a magician's act, a house of cards. Precious metals should benefit.

The Labor Department reported that, using their methods of counting, U.S. Producer Prices as measured by their Producer Price Index (PPI) actually declined, depressed, down 0.6 percent in January. This is part of the delusion of inflation restraint while money supply is quietly hyper-inflated. Fresh printed money gets into the system by the Fed buying anything, taking possession of anything, in exchange for that fresh new money. If the Fed buys bonds, the bond market catches a bid and rallies, and money gets into the economy. Anyone holding bonds feels wealthier and can use the higher priced portfolio to qualify to borrow more money (also causing the money supply to grow). They can take that loan and buy real estate, thereby putting pressure on housing prices to rise, alleviating the housing crunch. If the Fed buys stocks through the Working Group, the Plunge Protection Team, same result. Equity markets rise on the fresh liquidity injection, catching the PPT's bid, creating a wealth effect for shareholders. Investors can use their higher priced stocks to borrow to buy real estate, or more stock, or diamonds, or art, or whatever. The Dollar is down the john in this scenario, so the Fed must keep their printing and buying activities a secret, pretend they are vigilant about inflation via garbage numbers reported by Labor, through toothless jawboning at congressional sessions, etc... Why it has gotten so bad that hardly anyone from congress showed up at the Bernanke meetings this week. They must figure, what is the point? Anything spoken is pure bologna anyway. The real action is in the secret PPT meetings and M-3 figures.

The Labor Department reported that Initial Jobless Claims rose a huge 44,000 last week to 357,000.

And the sum of all this is that according to the University of Michigan, their Consumer Sentiment Index fell to 93.3 in February from 96.9 in January, as reported Friday at Get ready.

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"And the Lord said, "Hear what the unrighteous judge said:
Now shall not God bring about justice for His elect,
who cry to Him day and night, and will He delay long over them?
I tell you that He will bring about justice for them speedily.
However, when the Son of Man comes, will He find faith on the earth?"

Luke 18:6-8

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Robert McHugh

Author: Robert McHugh

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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