Cycles, Recessions, and Looking Forward

Forecasting cyclical turning points in the economy (and inflation) is job one at the aEconomic Cycle Research Institute (ECRI), a New York consultancy. In fact, it seems to do so rather well, or at least it has in the past. Notably, ECRI has earned some well-deserved praise in recent years for correctly predicting the 2001 recession.

But the current downturn has been a little trickier. True, ECRI was warning of trouble in late-2007. Even so, the firm held out hope that a recession might be sidestepped. As discussed in a November 2007 report, ECRI explained that "the leading indexes are not yet in a recessionary configuration, thus a recession can still be avoided." Alas, it was not to be. With the clarity of hindsight, we know that the recession began in December 2007, as per NBER's official (albeit 12-month lagged) dating of the downturn's start.

To be fair, ECRI was advising that a downturn was possible well ahead of December 2007. Today, the firm counsels that the recession is well entrenched and that economic contraction looks set to roll on. "The bad news is that the recession is going to continue for the next couple of quarters, and we know that objectively from the leading indexes," says Lakshman Achuthan, managing director of ECRI and co-author of Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy.

In an interview earlier today with The Capital Spectator, Lakshman talked of recessions, how we got into this mess and the outlook for, one day, better times. If you have a taste for the ugly details of the business cycle, read on…

Lakshman, ECRI did a nice job of predicting the 2001 recession. Were you ahead of the curve this time?

No, we were much more coincident, for a whole host of reasons. We said a recession was unavoidable in early March 2008. The reason we held out some hope that the recession could be forestalled was because of a weird confluence of events going on at the end of 2007 and early 2008 with respect to inventories—manufacturing stuff in the U.S. economy.

Typically recessions are kick started in many examples by a big inventory overhang that, all of a sudden, in sort of a Wile E. Coyote moment, give way and the floor falls out from under manufacturers. They realize that they have way too much inventory and they stop [producing]. That's how a lot of recessions tend to start.

But not this time.

No, it didn't happen that way. There was very little inventory and so we didn't have that kind of downturn in the economy. That gave policymakers the briefest window of opportunity to maybe push [the recession] off. But they weren't that worried and thought they had things pretty much under control. And we had growth abroad that was still drawing on U.S. manufacturers and so there was a widely held belief that we didn't have to worry about [recession] and that we were managing the home price decline and the emerging credit crunch quite well.

The economic cycle has in fact been sending some false signals, or certainly misleading signals in recent years, or so it seems. Inflation, for example, was running hot in the first half of 2008. But by the end of the year, deflation seemed to be the big threat.

Yes, it's been very schizophrenic. For example, the assumption in many models was that home prices couldn't go down; now the assumption is that they can't go up. All along the way there were plenty of prognosticators saying extreme things. Today there are some expecting a depression while others are expecting things to rebound in the second half of this year.

Looking back, you can see how this recession was set up. Certainly oil was part of the reason. We started to have oil spikes in 2005, and every year since then, through early 2008, we had oil spikes. Every time you had an oil price spike, someone warned of recession. When you had the housing market downturn begin in 2005, and you combine that with an oil spike, a lot of people saw recession.

But those were false signals, at least for a few years after 2005.

Right, and instead what we saw was that the economy accelerated to a four-year high with the growth rate in 2007. That's kind of an inconvenient fact. We actually grew faster than Europe in 2007. This wreaked havoc with all kinds of assumptions that decision makers had taken. In fact, the acceleration in 2007 may have lit the match for a lot of this credit stuff.

How so?

Because decision makers in the fixed-income markets and other markets were looking for a recession in 2007, but it never happened. You had the expectation on Wall Street, at Merrill Lynch and Goldman Sachs, for instance, of a 75-to-100 basis point rate cut by the Fed. And then one day in early June those two houses, which have a lot of followers, abruptly turned on a dime and said they didn't think there would be any rate cuts in 2007. What this did was immediately wreak havoc with all of the models pricing subprime credit groups, where the assumption was that rates would go down and so those instruments would maintain their credit ratings. The minute you took out the rate cuts, the guise fell away and everyone started running away from subprime debt very quickly. And that continues today.

So you had a housing price downturn that began in 2006 and then morphed into a credit crunch in 2007. These are massive things that take time to resolve. But they don't in and of themselves mean that you must have a recession. Our indicators were saying, yeah, things were bad, but it wasn't a guaranteed recession.

When did things take a turn for the worse in terms of triggering a real economic contraction?

We started to get a real recession risk in the second half of 2007. Our weekly leading index peaked in June 2007, about six months before the recession actually began in December 2007. In fact, by December 2007, our weekly leading index had plunged to its worst reading since the 2001 recession. However, because of these inventory issues I mentioned [there was an expectation that] maybe we would be able to buy a little bit of breathing room. That didn't happen. You saw the recession begin at the end of 2007. All the dead bodies started showing up in 2008 as the recession turbocharged the housing downturn and credit crisis.

What's the outlook now?

The outlook remains recession. Retail sales, the Fed Beige Books, industrial production, jobs growth—these are all coincident indicators and they confirm that we're in the most severe recession in the post-World War II era. This was forecast by our weekly leading indicators. Our leading index had earlier fallen to a 60-year low. So it's not a surprise that the coincident indicators are now weak.

What has changed in very recent weeks is that the leading indicators have begun to stabilize. I'm not suggesting that there's an imminent recovery ahead, but it is notable that we've gone from minus 30% growth rates to minus 25%, minus 28% or so. I suspect this is largely related to hope. We have a new year. We also have a new administration and some new stewards of the economy. There's talk of a new stimulus plan. The leading index may be showing there's some pause to this sharp decline. However, an objective reading of the index doesn't yet show a sustained recovery. That would require a very persistent and pronounced rise in the leading index for us to make that kind of forecast. What we know objectively is that the first two quarters of 2009 are going to be recession quarters.

The longest previous recessions were 16 months each, in the early 1970s and early 1980s.
If we date the current recession's start to December 2007, that suggests that we'll soon match the previous recessions' 16-month time frames. Does that mean we'll be getting close to the end of the current downturn later this year?

Saying at this point that the recession will end in the second half is really a coin toss — no one really knows. We don't know because the leading indicators haven't turned up yet. The bad news is that the recession is going to continue for the next couple of quarters, and we know that objectively from the leading indexes. The good news is that the leading indexes can't see that far. A lot of it is going to depend on, for example, the stimulus debate. If the stimulus is three times the proposed size and it happens quickly, then that's one extreme and so there's probably a chance of some kind of bump in the second half of 2009. On the other hand, if the stimulus is delayed, or adjusted down, maybe there's less chance.

Keep in mind that the recessions of the early 1970s and early 1980s were also international recessions. The number of countries in recession around the world today is the broadest we've seen since World War II. It's broader now than it was in the 1970s and 1980s in terms of the diffusion and pervasiveness of the recessions globally. That informs our view of what may happen in the U.S. There's a linkage: The broader the recession, very often the longer it is.

Comments

[User 265729:]

You can throw all of your books out the window my friends. This isn't in the textbooks.

Never before has an economy as large as ours attempted to survive based 75 percent on consumption, with another 10 percent based on building and selling houses to each other.

The fuel for all of this -- savings and higher wages? Not a chance! Try the total abuse of credit based on thin air assets. No more credit? No problem! We'll just trick all of our overseas friends into buying up our debt and package it like it was the opportunity of a lifetime.

Recovery in Q3? Q4? Well.. Depends on what year you are talking about, doesn't it. If you are thinking 2009 -- HA! HA!

Why would ANYBODY who actually visits stores and shops for themselves in stores (excludes members of the Fed, political leaders, etc) be surprised? After the holidays stores are EMPTY! I mean EMPTY. They don't have enough business to pay the electric bill, let alone make a profit.

What gets us out of this? Spending from the government? Another big HA! HA! They can't front or print enough money to cover the tens of $trillions of wealth loss over the last year, let alone cover for the increasing future losses.

Dig in my fellow Americans. This is going to be with us for years, if not decades.

Jan 14 05:16 PM

[Consider_this:]

Nothing goes straight up; Similarly, nothing goes straight down, not even in the 30s.

Right now there is too many shorts and too much pessimism in the market.

I agree the general direction is down, but recent action market action is too extreme, and can be explained if you assume majority of the market is now short or trying to run to safety.

This implies there'll be a "short killing short" squeeze event soon. It would lend (false) credibility to people shouting 2nd half recovery while simultaneously killing all the short profits.

Only when the market truly factors in optimistically expects 2nd half recovery, will we have our final leg down.

Even then, we're not anywhere close to the final showdown yet. Just look at how Japan's stock market swing and swooned.

This is a long war and each individual battle doesn't decide the outcome.

Jan 14 05:37 PM

[Jackson Cash:]

I think stimulus in the right places is needed.

This does NOT mean those that created the problems get the stimulus, contrary to nearly every politician. Banks are utterly out of control in the US and arguably the world. Power is as corrupt as the banks are in power.

The previous poster is optimistic compared to the forecast that I would predict.

Have financial problems? Thank a banker (preferably with your fist).

Jan 14 05:38 PM

[Moon Kil Woong:]

Nextel bankrupt. I think things will get much worse before it gets better. Unemployment strikes at the core of financial stability that housing doesn't do.

Once again all these market forecasters have their head in the sand. ECRI is one of the better of the many economy based predictive research groups. Much much better than the Fed or the Treasury. After all, they are looking for the facts not spinning them.

Jan 14 06:41 PM

[John Ryskamp:]

ECRI didn't tell you that a lot of its model was, and still is, based on liquidity. Nothing you could tell them about the non-liquid nature of this "liquidity" would induce them to change their model. And they still haven't changed it.

Remember when people talked about liquidity? Wasn't so very long ago.

Wanna know where to look to find the true facts about the depth of the economic catastrophe: the supply chain. Every single link is financed, and every single financial arrangement is corrupt.

Jan 14 07:01 PM

[CautiousInv...:]

I am a huge fan of John Mauldin and he has been looking at GNP calculated without the effect of mortgage equity withdrawls.

On this basis, growth in GNP was less than 1% in 2004 and 2005 and slightly more than 1% in 2006 when MEW totaled around $700 billion.

He made it very clear that the handwriting was on the wall.

Jan 14 07:09 PM

[prudentinve...:]

You state ".. If the stimulus is three times the proposed size and it happens quickly....." then "On the other hand, if the stimulus is delayed, or adjusted down, maybe there's less chance..."

The author is suggesting that the more stimulus and the sooner it is scattered around, the better off we will all be.

It is surprising how many people think that stimulus is a net plus, not a zero sum game.

Fact is that stimulus has to be paid for at some time and by somebody. If the money is just printed, somebody's savings will shrink in real terms and that person will have less real purchasing power as a result. If the money is borrowed, somebody will pay more tax and that person will also have less purchasing power.

So, at the end of the day, stimulus is just borrowing from the future and/or redistributing purchasing power in an artificial way. Excessive borrowing from the future is what got us into this mess; so more of it is throwing fuel on a fire. Re-distribution of purchasing power by governments is what made the planned economies of the Soviet Union and Maoist China collapse.

So, in reality, proponents of stimulus are just betting that the short-term boost will more than offset the fundamental long-term damage done to the economy. Only time will tell if they are right or wrong.

Jan 14 08:40 PM

[slickvguy:]

The private sector went on a spending binge that it couldn't really afford, and disaster ensues. So what's the government's solution? You got it...spending binge that America can't really afford. Likewise, we got intot his mess thanks to Greenspan not allowing the tech bubble burst to play out. He fought the recession tooth and nail, lowered rates too low for too long, and the rest is history. So what's the govt doing now? Same thing. Instead of allowing the pain to take place NOW so that a true recovery can happen, they are fighting it tooth and nail, which will only delay the inevtiable. Propping up GM? Why in the world would you back your losers instead of your winners? How much more money to be thrown at Citigroup? At AIG? At FNM/FRE? Is there a single major financial company that was properly managed? (And please don't tell me Wells Fargo - they were BETTER than the others, but still not great).

The Treasury and the Fed have been wrong every step of the way. It would be funny if it wasn't so tragic. They have been ridiculously inconsistent and behind the curve. And now we're supposed to trust them to finally get it right? I don't think so. I realize they have an impossible job, but they haven't helped matters by their actions. They've made things worse. Here's my advice to the government: GET THE HELL OUT OF THE F'N WAY! Let the free market take care of this. Let's have a depression if we must. Clear out all the garbage and start over again. Let the winners win and the losers lose. Only then will we be able to rebuild properly.

And this stimulus miracle? What a crock. Did this guy in the article actualyl say 3x the proposed size? WTF? Why would he say that? There's zero chance of that happening. Waiting for govt. spending to save the economy? Are you kidding me? First, it'll have a very small impact. Second, it'll result in higher taxes (or far less public spending) down the road.

Jan 14 09:32 PM

[User 265729:]

Condiser_this, Consider this...

It was just reported that facory orders in Japan fell by 16.2 percent -- the most on record. What did the economists think and project? A fall of 8 precent -- they missed it by more than double.

Most people do not understand how this vortex is sucking up everything around it. It is consuming everything in its path. It is bigger than the Fed and bigger than the governments trying to stop it. Wealth has plunged off a cliff in the United States, by perhaps $12-15 trillion last year, if not more.

Let me put it this way, by the time Obama's package is passed, the U.S. could lose another $2-3 trillion in wealth -- from today. All of this has taken years/decades to build up and it's going up in smoke before our eyes.

This is not 1928... Far from it. We should be so lucky that this will be like 1928.


On Jan 14 05:37 PM Consider_this wrote:

> Nothing goes straight up; Similarly, nothing goes straight down,
> not even in the 30s.
>
> Right now there is too many shorts and too much pessimism in the
> market.
>
> I agree the general direction is down, but recent action market action
> is too extreme, and can be explained if you assume majority of the
> market is now short or trying to run to safety.
>
> This implies there'll be a "short killing short" squeeze event soon.
> It would lend (false) credibility to people shouting 2nd half recovery
> while simultaneously killing all the short profits.
>
> Only when the market truly factors in optimistically expects 2nd
> half recovery, will we have our final leg down.
>
> Even then, we're not anywhere close to the final showdown yet. Just
> look at how Japan's stock market swing and swooned.
>
> This is a long war and each individual battle doesn't decide the
> outcome.

Jan 14 09:46 PM

[Jared Schne...:]

I cannot wait until this is all over! We just need some conservative growth. We need to get back to normalcy. Our country got out of hand and too greedy; now we're suffering for it.

Let's get back to the basics US. We need innovation and entrepreneurship because technology and small businesses drive our country.

Jan 14 11:03 PM

[zalo:]

The Mexican crisis originated a latin american crisis in the same way that the housing crisis has triggered a credit/financial crisis. When the mexican debt crisis started, the american government implemented the Brady Plan to reestructure Latin American debts to US Banks, and sell them to investors. In this way, they cleaned the US Banks balance sheets and reestructured the latin debt. Why not a Housing Brady?. The difference that i see necessary from the actual plans is that a huge cash pool should be made available to mostgage debtors (not banks), where they can get the cash to prepay and refinance their motgages o convenient terms. The government can then sell the Housing Brady Bonds with certain government collateral to investors and recoup their money. As the mortgage debtor will be owing to a special rescue fund from the government, instead of a bank, they will feel morally compelled to pay instead of walking away.

Jan 15 12:22 AM

[Anthony Alfidi:]

Now it appears that HSBC's capital position is much wose than previously thought. The next leg of bank asset writedowns (and thus market declines) is about to begin.

Jan 15 12:28 AM

[John Lounsbury:]

James Picerno - - -

Very well balanced discussionof the issues. Thanks.

Commenters - - -

I think you are wise to be skeptical about a bottom to this recession in 2009. Too many people are predicting it, just like too many people were predicting a 2008 downturn with recovery in 3Q/08.

A couple of articles worth reading published earlier today:
seekingalpha.com/artic...
seekingalpha.com/artic...

Also read the Beige Book article - first related article listed above.

Jan 15 12:32 AM

[Lin:]

Curbs -in

You are soo correct ! All readers , PLEASE see website : Countrahour
, see article entitled " The coming Great Depression " by Martin Armstrong .
This writer is one of the best I've read re what's ahead . like I repeatedly state . " 1928 will look like a walk in the park ." This Depression will last 23-26 years ! Curbs-in : I feel like I know you

Jan 15 12:43 AM

[Nikola:]

It's interesting all these comments came after yesterday's -3% session. Just a few days ago, as the market was flying people were talking about a recovery.

We can go and look at this number or that, and argue to death of its importance compared to other numbers. But for me, the bottom line for this mess is confidence. And I think that's also apparent in comments here, among investors.

Yes, I do believe that if people believe we'll get out of this in 2009, we will. If people do not believe it, we won't. Yes, I believe it's going to be a self-fulfilling prophecy.

So, for me, the big question is will Obama's team be able to return confidence to the market and consumers. If they manage to do that, we'll be on the way out of this recession in 2H 09, I don't care what the fundamentals say. If they don't... I don't care what the fundamentals say... we'll be stuck in Japan-land for a few years at least.

We'll find out soon enough.

There is not a lot of things Obama can do. It's TARP II time. A lot more important than the contents of it is how TARP II passes. Is there going to be bickering, or is everyone going to get behind it. Is it gonna fail once-twice in House or Senate. How much pork.

There might be a short bump after inauguration. (Expect comments here on SA to all declare a new bull market). Unfortunately, we will have to wait a bit longer than that. Hopefully not too long. I really do hope Obama hits the ground running.

Jan 15 01:01 AM

[Steven Hansen:]

Today, after reading between the lines on Bernanke's speech in London - we are farting in the wind with the stimulus package. Enjoy the ride.

Jan 15 04:32 AM

[flow5:]

Economists know very little about economics.

Aggregate demand is measured by monetary flows (MVt), or the volume of money times its rate of turnover. Rates of change in monetary flows reflect rates-of-change in both the proxies for real-gdp & inflation.

Bank debits represent monetary flows, i.e., money is the measure of liquidity and its rate of turnover is represented by the transactions velocity of money.

Economic forecasts are virtually infallable using bank debits. Of course, the trend can be influenced by changes in the FOMC's monetary policy (or by the rate-of-change in legal reserves).

The primary reason forecasts are impossible to miss is that the monetary lags for real-gdp & inflation are always exactly the same. In contrast to all economists, they never vary.

So, it takes x number of months to complete the cycle for each proxy. I.e., it takes so... many months, that if economists know MVt for 75% of the months (or the majority of the months in a cycle), they can predict with reasonable accuracy, what the remaining months contribution to GDP will be.

Be stupid, be ignorant, or be arrogant. This analysis is inviolate and sacrosanct.

Jan 15 11:28 AM

[shootpar2001:]

Hey!!! Everybody.
The 'details' have been discussed to death.
We are 'Seeking Alpha', or so I thought.

Let us discuss moving up/down the risk/reward ladder for some money.

I'll start!!
I am dipping a toe down the credit ladder, taking some risk to get some
return. Is anybody else? How far down the ladder are you willing to go?

I have noticed large interday swings between Treasuries and bond funds.
Also, some of the preferred offerings are seeing increased volume.

Comments welcome.

Disclosures: (PGF), (PSY), (ACG)

Jan 15 11:51 AM