I was embarrassed> to be among the last to admit the economy had fallen into recession in 2008. I was proud to be among the first to recognize the recession's end last May. But is it too early to do a victory lap on that? Could the economy be slipping back into recession? The way the stock market has stalled out, it's a question that we really have to ask ourselves whether we like the answer or not.
First of all, the end of the recession isn't yet "official." In a trivial sense, all that really means is that the National Bureau of Economic Research hasn't declared it over. But that doesn't mean it isn't over. The NBER has many times waited years to declare what, by that time, everybody knows.
In a deeper sense, there is no rigid definition for "recession," so the NBER's decision, whenever it comes, is subjective. Even more deeply, if we grant some kind of common-sense intuitive definition, once it is achieved and recognized there is no guarantee that a new recession won't already be underway.
To try to make it as objective as possible, I like the work of UCLA economist Edward Leamer, who has devised a very simple formula --using just three readily available economic statistics -- which has a nearly perfect track record of nailing the beginning and ends of recessions precisely as the NBER does. I'm not saying Leamer's model predicts the economy. I'm saying it recognizes when conditions have gotten to a point that, historically, has caused the NBER to "make it official."
Leamer's model looks at industrial production, payroll jobs, and the unemployment rate. Given where those three statistics are right now, his formula isn't quite ready to declare the recession over. It's close. It will probably happen next month, unless the jobs market sharply weakens. When the formula gives its signal, there's another formula for looking back and determining the timing of the turning point. It's looking that that formula will pick last May, the same as I did in real time.
I made my recession end call in May because of an entirely different set of statistics, designed to be predictive rather than merely to recognize what has already happened. What worries me is that these statistics have all started to get a little worse recently.
The one that gave the earliest indication of the end of recession was the number of claims for unemployment benefits. As I wrote here in May, when claims turn down after a long uptrend (that is, when fewer people file for unemployment benefits) that means the recession is only about a month or two from being over. That indicator has a perfect track record, as far back as the data goes.
The top in initial claims was in early April, and it's been steadily heading down ever since. Right now the 4-week moving average is 28% below its peak -- a very substantial move. The problem is that several weeks ago it was 33% lower -- which means it has risen more than 7% in a very short time. Over history, upticks like that have no predictive value. There have been many of them, and very few have led to recessions. Still, 7% is a big reversal. In
May when I got excited about the drop in claims, that drop was only about 4%!
Another infallible indicator -- or at least one with a perfect track record -- is consensus earnings expectations for the S&P 500. After a horrific 38% decline, expected earnings started to turn around last April at the same time as claims started to fall. Having these two "perfect" indicators kick in at the same time was a very convincing signal for me.
The problem now is that expected earnings are now growing at a much slower pace. They haven't rolled over yet by any means -- that is, expectations aren't being lowered, they're just rising at a slower pace. The one could lead to the other.
The third element that fell into place last May was credit spreads. By that I mean the extra yield that bond investors demand to take the risk of corporate bonds instead of riskless Treasury bonds. At the worst of the credit crisis, the spread between Treasuries and so-called "junk" bonds was 19%, the widest spread in history. By May, it had fallen below 10%, the level typically seen at the end of recessions. It has since moved below 5%, indicating the investors are once again ready to lend money at reasonable rates.
The problem is that it's been creeping back up for the last month or so, now at about 6%. That's not a horrible level in and of itself. But it's moving in the wrong direction.
Finally, there's the dollar. The dollar soared during the credit crisis, reaching its top the same day in March last year when the S&P 500 hit bottom, as investors sought the safety of cash. As stocks and the economy have recovered, the dollar has fallen sharply. That's a good thing. It means investors aren't so scared anymore.
The problem is that the dollar has rallied about 10% over the last couple months. Does that mean that the fear that gripped world markets in 2008 and 2009 is returning?
Remember that in May, when I was observing a very good month under our belt in these four key indicators, we also had just experienced two months of a very strong stock market, launching off the early March bottom.
The problem now is that stocks have stopped going up. They're not crashing or anything. But last January 19 was at least an interim top, with stocks slogging within a 10% range below that ever since. For that matter, except for a brief and unsustainable surge in early January, stocks have done pretty much nothing since November.
So is the economic recovery over? I don't think so. I think it's just being tested. None of the indicators I use to detect the onset of recession are giving signals. But it's haunting, nevertheless. After the horrific global recession we went through, you'd think we ought to come roaring back. We're back, but we're not exactly roaring.
This confirms my intuition that, while we are in a recovery, not a recession, we aren't yet in a true expansion. It seems that we're going to have to earn that the old fashioned way, with a great deal of patience. The risk is that we won't be patient, but instead that we get scared. We could talk ourselves into another recession just by pulling back from economic activity as a result of fear. A perfect self-fulfilling prophecy.
I hope we don't do that to ourselves. I don't expect we will. But in the meantime, we're going to have to sweat it out. That means more correction and consolidation for stocks.