While the majority of investors are focused on the Eurozone, particularly France, Germany, and the European System of Financial Supervisors (ESFS), many are forgetting the United States economy may be severely hindered by a recession. The good news is that employment data improved through September, however eerie statements such as "moderate growth in employment is consistent with the recent deceleration in GDP" signals the economy is far from open pastures. Two other indications of a possible recession are Bank of America's (BAC) downward trend on the financial sheets and the United States Postal Service's (USPS) downward spiral.
One question investors may be asking is how Bank of America and the USPS indicate a possible recession? To begin, Bank of America demonstrates an economic slowdown in five ways. First, the attempts to raise capital should be a signal Bank of America is bracing itself for a possible recession in order to avoid a catastrophic collapse as we saw with Lehman Brothers. One way the firm is prepping its coffers for a recession is the allowance of Berkshire Hathaway (BRK.A), led by investment mogul Warren Buffett, to invest $5 billion in Bank of America in a manner that clearly favors Berkshire. Secondly, the credit downgrade in September indicates Bank of America may suffer large losses in the future due to exposure to other failing banks as well as backed up mortgages lingering from the housing collapse. From Moody's report:
Moody's believes BAC has ample resources to absorb the additional losses it is likely to experience on these exposures. However, if the economic environment were to deteriorate and the bank were to receive adverse legal rulings on the claims pending against it related to its mortgage business, it could have a significant impact on BAC's capital position. Moody's also believes the variability around potential negative outcomes is substantial, and their resolution is not entirely within the direct control of management.
A third caution flag Bank of America is giving to investors regarding a recession is the recent proposal to move derivatives from Merrill Lynch to an insured subsidiary. It is important to note this has not been confirmed, however if this is true it indicates Bank of America may be playing a speculative game and is facing a check mate very soon. The possible end game indicates a recessionary environment because, again, the bank is preparing itself for substantial losses in the equities market.
Two more changes Bank of America is proposing is the pesky $5 debit card fee as well as a plan to eliminate 30,000 employees over the next few years to save $5 billion per year. These may seem miniscule, but both indicate the firm is attempting to raise and save capital in the event an economic slowdown and recession. Do these five changes demonstrate a recession will occur within the next 12 months? Not necessarily, however the question can be raised as to whether Bank of America foresees a recession and is preparing early to avoid substantial losses. This idea is much more plausible and may in fact be what the firm is doing.
I will continue with Bank of America later, but for now it is important to address how the USPS is signaling a possible recession within the next 12-16 months. In order to properly understand how the USPS is foreshadowing a recession, I must digress for a moment to discuss what the USPS symbolizes. Briefly, the USPS delivers mail and packages across the country. Therefore if the USPS is not delivering as much mail it can be argued consumers do not have the extra income to send letters and packages. On the other hand, it can easily be argued email is taking the place of letters. Not to mention startup mail service companies are offering secure and efficient mail delivery options via the internet.
While these startups offer fantastic opportunities for consumers, the fact is that consumers are spending less on mail and one possible reason for this is a lack of consumer expenditures due to a slowing economy. As you can see below, there is a correlation between volume of mail shipped with revenue and operating income. All three variables began a decline prior to the previous recession, followed by steep plunges during the recession. Two years later the USPS has not recovered and this may manifest another steep decline in the near future.
After the steep decline in volume in 2009, we should see a flat line for 2-4 years. We have already seen this in 2010 and 2011, and this trend should continue through 2012 and possibly 2013 because the economy is still wavering. As mail volume continues to stagnate and slowly decrease it should be a forewarning, based upon historical patterns, that the economy is slipping into a recession. This is the reason the USPS is suggesting a recession within the next 12-16 months.
USPS Financial Data
More importantly, Bank of America has reported decreased revenue almost on a sequential basis since 2006. It is also important to note Bank of America produced a sequential increase in revenue, on a FTE basis, and net income from 2002-2006. This sequential increase in revenue and net income prior to the previous recession is important because it gives us a pattern to predict future recessions. In order to anticipate future pre-recession trends it is important to combine, compare and contrast yearly financial trends with quarterly financial trends. By analyzing the yearly trends and quarterly trends of Bank of America, it is possible to foresee recessions and gain an edge on the equities market in order to avoid substantial monetary losses.
As you can see above, an important trend to note regarding net income is the sequential increase I mentioned above prior to the housing collapse. Surprisingly, prior to the official recession, Bank of America's net income decreased substantially in 2007. This indicates it is possible for Bank of America to experience a significant decline in net income the year prior to an actual recession. If this occurs again, it brings to the floor whether Bank of America is predicting a recession in 2012 because the firm's full year 2010 net income was well below 2009. A counterargument to this is the fact that Bank of America is still dealing with mortgage losses; which is draining net income. While this may be true, this type of volatility in the economy suggests the United States is far from being clear from a recessionary environment.
With the yearly financial trends dealt with, we can now discuss the quarterly results since the first quarter of 2010. Two important trends can be noticed. First we can see revenue is following a steady decline. If not for the third quarter of 2011 financial results, Bank of America's revenue would follow a steeper negative slope. Two possible results will come of this. On the one hand if Bank of America continues to improve revenue to the $30 billion level, it will be difficult to argue a recession is imminent. On the other hand, if Bank of America is unable to continue the upward trend in revenue, the firm will be signaling a recession.
The second trend to notice regards net income. While quarterly net income has seen more volatile movement contrasted with revenue, the firm's net income follows a much flatter trend line. This trend line indicates that over the past seven quarters Bank of America has been unable to improve income for shareholders. Aside from the current argument, this lack of net income is directly related to the 60% decline in share price over the past two years.
This leads us back to the question of how does Bank of America signal a recession? The main indicator is revenue. While the third quarter was surprisingly high, the trend is in the negative direction. If this continues through the first half of 2012, I must reiterate, the firm will be signaling a recession in the fourth quarter of 2012 or 2013. Two important signs will occur that will enable investors to spot an equities market collapse prior to the said collapse. First, as mentioned when discussing yearly net income, we should see a significant decline in net income over a 2-4 quarter period. Secondly, revenue will stagnate or decline slightly over a 2-4 quarter period.
It can be argued we have already seen this in 2010 and the first half of 2011. First, net income plunged in the second quarter of 2011. And secondly, revenue declined substantially from 2009 to 2010. These two data points indicate a recession is a serious possibility within 12-16 months.
This brings us to the forefront of this note, which hinted that investors should be more focused on an American recession rather than the soap opera in Europe. With that said, I pose one final question: when will the next recession occur? I do not know the answer, but I must echo the main point, which is; Bank of America and the USPS make it clear a recession is a threat within the next 12-16 months. It is also important to note I am not intending to encourage investors to sell any long positions in Bank of America. Furthermore, while these two entities are signaling a recession, this does not mean the economy is destined for a recession. There is time to turn the economy around, however it will be difficult to tread through the muddy waters ahead.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.