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Recession
Report Card: Is It Really Over? |
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Though the subject
is often treated like a 'touchy-feely' idea, it's dangerous to leave matters
like an end of an economic recession up to a matter of opinion. See, opinions
can be biased.... jaded. As such, they can obscure the truth.
Though easier
said than done, calling an end to a recession should be a relatively technical
matter, particularly if it's the technical criteria that define
the beginning of a recession.
With that in
mind, today we've got a scientific look at the economy's 'health' criteria.
The snapshot may surprise you. Before we get to it though, we'll also offer
you a heads-up on the follow-up to today's comments. It will be coming
later this week, and adds a layer of sector/industry detail to today's
recession/recovery discussion.
We've
always interpreted economic data as specifically and as carefully as possible,
striving to not let opinions or assumptions unduly influence us. The core
of that economic-based forecasting strategy was discussed way back in September
of 2007 (Economic
Reality 101).
 Since
then - though the basics haven't changed - we've certainly tweaked
our definition of what a recession looks like. More importantly, based
on the prior five recessions going back to 1970, we've defined quite clearly
what the end of a recession should look like by identifying precisely
what unemployment, inflation, the Fed Funds rate, and capacity utilization
looked like before, during, and after the recession. First things first
though.
Though we've
touched on this before, we may have never actually come out and said rising
unemployment, peaking (or peaked) inflation, falling capacity utilization,
and a falling Fed Funds rate (or discount rate) were all tell-tale signs
that a recession has already begun. They are though.... all four
were common to all of our recent recessions.
In the same
vein, all of our recent recessions ended with the same basic situation....
falling unemployment, increasing capacity utilization, stabilizing or rising
interest rates, and inflation that was falling or stable.
(It's worth
clarifying that each of those individual hints can and do exist by themselves
without necessarily occurring at the beginning of a new economic expansion.
We specifically mean all four clues occur simultaneously at the
beginning of a new growth phase.)
 The
nearby chart illustrates all of this fairly well. The recessionary periods
- as defined
by the NBER - are highlighted in yellow. If you want a larger,
more detailed chart of the same, then click
here.
So where
is the economy now in terms of those four indications? It's healthier
than it was, but nowhere near as healthy as a lot of folks would guess.
Let's just roll through each of them one at a time.
Unemployment
- Don't worry that an unemployment rate near double digit (it's at 9.8%
right now) is 'too high'. There is no 'too high' level to overcome, as
we saw in 1982 when it peaked at 10.8%. Only the direction of the
unemployment trend matters. And even then, notice that unemployment can
continue to drift higher even after the recession is over, as we saw in
1991 and 2002.
On the other
hand, considering the unemployment can and has just as easily made a sharp
reversal at the end of other recessions, a nice mountain-top-shaped reversal
here would be a huge boost.
Bottom line?
We're not pessimistic based on this data, but it's no reason for optimism
either.
And on a side
note, the unemployment rate data itself has been criticized by many as
being minimized by the government, and not reflective of the true unemployment
rate. The true rate if employment is closer to 15%, according to some.
The complaints are not without merit. However, a 'contained' figure is
nothing new.... prior unemployment rate surges were just as subject to
manipulation and containment. Point being, it's still - mostly -
an apples to apples comparison even if it's the same wrong apples being
compared.
Capacity
Utilization - This is by far the most encouraging shred of data, yet
one of the most unsung. We've seen three consecutive monthly increases
in utilized capacity following a multi-decade bottom at 68.3% (from June).
Given just how reliable this piece of data has been when it comes to spotting
economic growth and contraction, this clearly is a major victory for the
economy.
Inflation
- This one's a bit tricky to read this time around, as we're dealing with
true deflation for the first time in decades (the inflation rate has been
negative since May).
Like we said
above, though the timing of the peak in inflation can come at different
stages in a recession, it is common to all of them at some point. And,
the end of a recession is essentially marked by rates that are stabilizing....
usually around 2.5%.
This presents
an obvious problem for the current situation. Inflation will have to rise
to get back to norms, even though rising inflation has traditionally hampered
the economy as well as the stock market.
Though obviously
not ideal, we'll tap a little common sense (seasoned with experience) and
say that an increase in the inflation rate from sub-zero levels to something
in the 2.5% area is a healthy thing. Moreover, inflation rates persistently
less than zero are actually an unhealthy influence.
As is stands
right now, we'll have to call this one a stalemate - inflation currently
poses both positive and negative hints.
 Fed
Funds Rate - Note that the Fed Funds rate largely goes hand in hand
with the inflation rate, though their synchronization can be a little off
at times. Essentially what we need to see here is stability.
Contrary to
popular belief, the economy can digest high interest rates, and low interest
rates aren't always stimulating. Stable interest rates, on the other hand,
have ushered in some of the market's best bullish phases. Needless to say,
with Fed Funds rate stuck at 0.5% since December, the market's once again
made good use of the predictability.
The risk here
is simply the possibility that Ben Bernanke will indeed start to scoot
rates higher soon to stave off inflation, thus ending the dovish period
from the Fed. The logic makes sense, save one problem..... WHAT INFLATION?
Yes,
the conditions are ripe for it. The Fed pumped billions of dollars into
the system, and interest rates are wildly low. We've not seen any inflation
yet though, and frankly, it would be better to see at least a little than
none at all.
Moreover, the
Fed's not unaware if how fragile this recovery process is; they're not
likely to do anything significant to upset what's been done so far.
So, like unemployment,
we're going to have to score the Fed Funds rate as a positive for the economy.
.
Not that we
were keeping score, but if we were, the economy would score a 2.5
out of 4.0 in terms of a full economic recovery. That's about a C average,
though it's far better than the F- grade from a year ago. As we said a
few weeks ago, it may not be pretty, but it is a recovery.
More important,
now we all have some context - some real criteria - to use when
gauging the economy's health. We'll be updating this chart as needed.
Be sure to look
for the second part of this overview later this week.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
