Seeking Signs of Recovery

I have been writing about the American economy on Seeking Alpha just over a year, since December of 2007. But it is only now that the full extent of my shortcomings as a writer has become clear: I have run out of adjectives that describe the terrible state of the American economy. Every month it’s the same: what’s bad got worse, and what’s good is less good than it was; next month will be the same. (See below for links to previous articles on the economy.)

Recently, however, I have noticed a few indicators that a turning point may not be too far away. A couple of words of caution: a 2009 recovery, though indicated by some measures, is still highly problematic. Worse, the recovery, whenever it comes, is going to be SLOW! Consumer spending, which fueled the bubble, will not be as robust as it was at the peak of the bubble. It will probably be restrained for several years, if not more.

My guess is that the economy will endure a subdued spending recovery, and a slow climb out of the deep hole we are in now. It will be a long time before we reach the production levels we enjoyed before the bubble burst. However, before our economy starts getting better, it must first stop getting worse.

The charts below show the current state of our economy. The first chart tracks job losses over the last 14 months, beginning in January, 2008, and ending in March, 2009. The bad news: we lost 663,000 jobs in March, similar to the February numbers, but less than January of this year and less than December of 2008.

The March figures were below expectations of many economists who follow this trend. In other words, many economists were looking for even worse job losses than were reported. So far, at least, job losses have slowed, at least a little.

The next chart shows stock prices (Dow Jones Industrial Average) over the same period. Since early March of this year, equity prices have been improving, although it is too early to know if this is a trend that will continue, or just a bounce leading to nowhere. If this is a true turning point, then we can reasonably look for a six to nine month lead time before the economy turns around. If this relationship holds during the current recession, then the economy could be expected to turn around sometimes between late September and the end of November of this year.

Be warned that the stock market is not a consistent indicator of recovery, although historically the market does turn up some months before the economy actually bottoms. It also sends false signals by turning up while the economy continues its plunge, so it can’t always be relied upon.

However, there is another forecast for a 2009 turnaround that uses the interest rate spread between two credit classes of corporate bonds as the basis for its prediction--the difference between yields of corporate bonds with a BAA rating and those rated as AAA. The forecaster, in this case, is Professor David Beckworth of Texas State University in San Marcos, TX. He has tested numerous models for their predictive powers, and came up with a strong correlation between the bond credit spread and future manufacturing activity.

He employs his computer model to predict Industrial Production by using only the BAA/AAA spread in a lagging scheme. The blue line in the graph below is actual industrial production through early October, 2008, and the red line is the projection of industrial production up to July, 2010. The forecast is based solely on past BAA-AAA spreads.

Projection of Industrial Production based on yield spread from the BAA grade commercial bonds to AAA

Mr. Beckworth insists that the BAA/AAA spread is a clear and unambiguous indicator of investor sentiment with respect to risks. A narrowing spread indicates more willingness to take risks, and a widening spread indicates a reluctance to do the same—demanding a higher return from the lower rated securities.

The turnaround in this projection is roughly August–October of this year. Overall it predicts about a 7.5% rise from the predicted trough in August through the predicted period that ends in July, 2010. The annualized rate of growth would be higher than 7.5%, since the trough and peak are separated by nine or ten months.

That is a robust recovery—and one I am skeptical of, as I have already pointed out. I don’t know how fast industrial production will recover, but I do know that manufacturers do not crank up production without an anticipation that their products can be sold. And if their products are going to be sold, there must be a good level of spending to support the sales. Unfortunately, there is little to indicate that consumer or business spending will recover from their current anemic levels any time soon.

The stimulus spending will help, by the way, but it is not going to be enough to replace the housing-induced spending frenzy we saw during the height of the real estate bubble. That kind of spending will not return for a long, long time.

Keep in mind that this projection is for industrial production, which is not the same as GDP, but it is a large component of GDP and a good indicator of the general health of the manufacturing sector of the economy.

There are other tentative signs that a recovery may be building for a worldwide recovery. Stock prices are showing some signs of recovering for emerging markets equities. The chart below shows the Vanguard ETF, VWO, Vanguard’s Emerging Markets Index. It shows a bottoming process similar to the American Dow Jones Industrial Average.

click to enlarge

The last chart, below, shows share prices of two ETFs: VWO, and Brazil (EWZ), except I changed the time frame to the last three months. This change will help highlight the recovery in prices of both VWO and EWZ during the first quarter of this year.

click to enlarge

It’s too early to make a definitive call on this turnaround, but if it does hold, it bodes well for a general recovery. If investment money is beginning to flow once again into the riskier emerging economies, it indicates a strong reversal of risk preferences that characterized this market for much of the last year.

Another encouraging sign is the conclusion of the G-20 meeting last week, where a trillion dollars of new money was pledged to the IMF and World Bank to help the emerging markets with currency loans and international trade financing for those countries most strapped by the slowdown.

This optimism may or may not hold. There could easily be reverses in all the indicators that give us positive signs. In my view, it is not Spring yet, but there are some signs that the economic flowers are beginning to bloom.

A list of my previous works directly related to economic analysis:

• 2008 Economic Outlook: Dominoes All in a Row (Jan 3, 2008)
• The Incredible Lightness of Being Employed (Jan 6, ‘08)
• Recession Talk Has Gone From How Bad to Worse (Jan 24, ’08)
• Stagflation and the Limits of Growth (Jul 10, ‘08)
• Batten Down the Hatches: Economic Forecast (Oct 5, ’08)
• Economic Outlook for 2009: A New Deal for a House of Cards (Dec 11, ’08)
• · Credit Started This Recession; It Will Also Help End It (Jan. 4, ’09)

Disclosure: Author holds positions in SPT, EFZ and EEM

Comments

[Sandeep Daga:]

The speed of decline has slowed but decline is yet a reality. Credit spreads are still quite tight, baltic index is falling again, housing prices have yet to show a definitive sign of stabilisation, East europe is in big trouble and commodities are rallying purely as one-off effect of China stimulus plan. Summers are, typically, featured with strengthening dollar and falling interests by Longs - I do not see why this is not a possibility this year. Charts of 1930s and 1979s suggest that we are half way through. A 'V' shaped recovery is not realism after having expected arrival of "Depression" not too long back. It is too early to hurrah !

Apr 09 08:06 PM

[E Nuff Sed:]

Yes this may not be the bottom but you cannot ignore a back to back 5 week rally which has given us a gain over 28%. On the next pull back a lot of investors sitting on the sidelines will be drawn towards stocks again.

docs.google.com/Presen...

Apr 09 08:31 PM

[djc:]

Cetin, wages were largely /stagnant/, as was job creation for quite awhile in the 03-07 recovery. 'Economists' and pundits were loving it, as it kept inflation pressures low, as many american jobs were offshored and aggregate wages stagnated.

CEO pay and perks, on the other hand, have done very well.

Apr 09 09:48 PM

[Ray Hendon:]

Cetin Hakimoglu: You are correct that homeowners cashing in (and spending) the equity of their home was not the only contributor to the spending bubble. My point is that spending was high for many reasons, including those you point out, but it was the last straw on an already supplied-constrained economy. It pushed prices much higher and contributed greatly to manufacturing output. Furthermore, this kind of bubble-associated spending will not return for a long time--and its presence will be missed, because it means a lower level of production and income for the nation. We will simply have to adjust to a little less than we got used to.

I'm not so sure I agree with you that spending will return to negative territory, later this year. The great depression left a huge mark on those who endured it. They saved more for all of the rest of their lives. They worked hard and spent frugally.

I am not saying that our current situation is near as traumatic as the great depression, but it is of significant magnitude to cause some permanent change. I think that Americans will be saving more for a long time, even past the beginning of the recovery. Confidence is shaken, and shaken citizens are more prone to pull back. I may be entirely wrong, and I hope I am, because a return to heavy spending would accelerate the recovery.

Thanks for the comments.

Best Wishes,

Ray

Apr 09 11:47 PM

[penny_stocks:]

The phrase “A return to heavy spending would accelerate the recovery”, this is intriguing and I’m afraid that you might be right.

People will not bite at this point and yeah you may say lots have chickened out. I guess people have learned a lot and are now being conservative, cautious and wiser.






On Apr 09 11:47 PM Ray Hendon wrote:

> Cetin Hakimoglu: You are correct that homeowners cashing in (and
> spending) the equity of their home was not the only contributor to
> the spending bubble. My point is that spending was high for many
> reasons, including those you point out, but it was the last straw
> on an already supplied-constrained economy. It pushed prices much
> higher and contributed greatly to manufacturing output. Furthermore,
> this kind of bubble-associated spending will not return for a long
> time--and its presence will be missed, because it means a lower level
> of production and income for the nation. We will simply have to
> adjust to a little less than we got used to.
>
> I'm not so sure I agree with you that spending will return to negative
> territory, later this year. The great depression left a huge mark
> on those who endured it. They saved more for all of the rest of
> their lives. They worked hard and spent frugally.
>
> I am not saying that our current situation is near as traumatic as
> the great depression, but it is of significant magnitude to cause
> some permanent change. I think that Americans will be saving more
> for a long time, even past the beginning of the recovery. Confidence
> is shaken, and shaken citizens are more prone to pull back. I may
> be entirely wrong, and I hope I am, because a return to heavy spending
> would accelerate the recovery.
>
> Thanks for the comments.
>
> Best Wishes,
>
> Ray
>

Apr 10 12:59 AM

[Duderonomy:]

Hold on a minute. You include unemployment numbers. As counterintuitive as this sounds, unemployment numbers are a lagging indicator. As I told my former employers (note former employers), unemployment actually accelerates at the end of a recession (backed up by numbers from the last severe recessions from 73-75 and 81-82 which peaked at the end of the recession). Why haven't you included the M2 increase or the treasury yield rates (which predicted the recession in the first place)? I also noticed you included VAR industrial production that is largely projected. There are some economists that believe we have deminished our inventories that could lead our industries to have to produce more products. I don't mean to make this sound like an attack, just a different way (perhaps naive) of looking at the economy.

Apr 10 01:17 AM

[Ray Hendon:]

Duderonomy: I did not use unemployment numbers: I used job losses--a related, but different measurement. I agree that the unemployment rate is a lagging indicator. It will come down some months after the recovery begins.

Business inventories have been sold down--that was and is the aim of businesses that are selling less than they planned. Once demand (spending) recovers, then inventories will be replenished, and production of those goods will be stepped up. But, if the increase in demand is tepid, as I fear it might be, then the recovery of inventory production will also be tepid. I don't know if it will work out that way, but my analysis points me in that direction.
I don't see us returning to previous levels of production in many areas--the spending required for that level of income just isn't going to be there for some time. I do believe we will have a recovery, but it isn't going to be a V-shaped. More like an elongated U--very elongated if my worst fears are right.

As far as other variables, I chose the ones that I think are relevant to a turnaround this year. Interest rates are important, as is the money supply, but if the economy is in a liquidity trap, as we are now, then monetary policy must take a secondary role. You can pour money into the banking system, but you can't make borrowers borrow, and you can't make lenders lend it they don't see it as to their own benefit. If factories are closing, there is not going to be much demand for borrowed money to build new ones.

Best wishes,

Ray

Apr 10 01:46 AM

[tziv:]

With city's and municiaplities on the verge of bankruptcy, because they spent more money than they had, shouldn'tthe same thing happen to the US gov't? www.thegrubspot.com/20.../

Apr 10 05:08 AM

[Ray Hendon:]

tziv: No, the federal government is the only governmental entity that is empowered to create money. States and municipalities do not have this power.

Creating money, by the way, is much different than printing money--these two functions are quite different and should not be confused.

Best wishes,

Ray

Apr 10 09:05 AM

[Bull Run:]

Ray; the robust recovery that your yield spreads on commercial paper are predicting,would under normal circumstance be hard to believe, but I think the graph may have some credince. Namely a period of hyperinflation, that the Feds have now created. The feds have injected some $13 trillion into the system, and that will inflate the economy. I think were seeing some signs of that now. The stock market may very well be a lead indicator of inflation as it acts as a hedge, similar to many S. American countries that faced huge infaltion levels. If one goes further to consider the mutiplying effect banks have in creating more money, the $13 trillion turns into $100, with a 8 times effect.That's inflation. This next recession, the one most feared by economists is almost non-recoverable.( currency failure) At present we are in a recession that is a Balance Sheet recession lead by Financials, much differnt than a fall in consumer spending recession that can be easily fixed with a couple of rate cuts. Rate cuts to correct a balance sheet recession are mostly useless, and have very little effect, as present day conditions indicate.The last major Balance Sheet recession the US suffered was suffered by the Regional Ohio rust belt industries. This produced many long term effects, but remained regional, unlike a Balance Sheet recession led by financials which is all across America, and nearly terminal, because banks are closely linked to the US dollar.I 'm guessing that this Balance sheet recession will slip into a full feldged hyperinflation period, followed by the world dropping the US dollar as the world currency, followed by a currency failure, which will drive America into the worst recession in history.Happy Easter.and a Good Friday

Apr 10 10:12 AM

[Smegma:]

Forget charts, fundamentals, technicals and earnings.

I've developed a fool-proof trading strategy, which I've been designing and refining for the last few weeks (specifically, since about March 10). It's complicated and esoteric, but since inception it has never failed:

Step 1: Buy SPY.

Step 2: Watch S&P rise.

Step 3: Sell SPY.

Step 4: Repeat.

It's proprietary and I will be marketing it to investors for a fee, but I'm divulging it to SeekingAlpha readers with my compliments.

I'd wish you all good luck, but as you can see above, you won't need it.

Apr 10 11:15 AM

[Ray Hendon:]

Bull Run: I must disagree with your predictions of inflation, at least for any time in the next year or so. American productive capacity is now running at about 66%. There is no room for price increases with this kind of excess capacity hanging around. Search the record and see it you can ever find a period of high inflation when capacity utilization was so low.

Don't be confused with the huge money supply increase with any change in prices. When a liquidity trap is working, as it is now, all the surplus cash pumped into the system just sloshes around financial institutions, doing no one any good, nor, doing any harm.

Once production recovers, then inflation become something to be concerned about, and at that time the Federal Reserve Open Market Committee will have a large agenda protecting price levels and the value of the dollar. But, to me, that seems a long way off.

I must confess, however, that I have no special looking glass that reveals the future. My guess are just that, guesses. It may turn out that my suppositions are 180 degrees off the mark.

Best wishes,

Ray

Apr 10 11:18 AM

[E Nuff Sed:]

I think this is an excellent article. Stockmarkets however are connected not only to fundamentals (i.e., economy/long term) but equally (if not more) to sentiment (technicals/short term).

In the last few weeks the tone of the technical s has changed and this in turn will feed on it self. This is called auto-correlation and the theoretical basis for momentum trading. As stocks enjoy success, shorts will continue to cover while money sitting on the sidelines will be drawn in. Skeptics will be converted and so on ...
{The cycle in a bear is the opposite (only much faster).}

If in a few months the fundamentals confirm the technical s then the bull will continue or alternatively the fundamentals do not confirm then the technical s will break down and we will dip into the a new low.

My intuition (hope) tells me the worst is over but my experience (fear) tells me its not.

Apr 10 11:23 AM

[Mad Hedge F...:]

Here's agood one. So there is life after near death! Wells Fargo (WFC) stunned the street with a surprise $3 billion profit in Q1, vastly better than expectations. The shocker was that charge offs from loan losses amounted to only $3.3 billion, a shadow of forecasts that ranged as high as $8 billion. Some analysts suspect that some creative accounting was involved in consolidating the losses from recently acquired Wachovia Bank (WB). Short sellers were seriously squeezed and no doubt are now speaking in voices several octaves higher, pushing the stock up an amazing 40%. The news triggered an all out assault on bank haters, there are still plenty out there, taking JP Morgan up 24% and Bank of America up 42%. A share of Citigroup at $3will now buy you a cup of coffee at Starbucks, but only if you get the cheap stuff. With the Fed raining money down on the sector and the Treasury changing the rule book almost daily to make this work, how else was this going to play out? This puts WFC first in line to repay TARP money and get the Feds out of their hair. It also underlines the argument that I have been making all along that if you put mark to market and asset valuation issues aside (no easy task), the banking business in now the most outrageously profitable in its long history.

Apr 10 04:38 PM

[fatcat:]

Ray,wouldn't a shortage of goods,caused by lack of production,make the prices go up...thus inflation...when demand returns? At least in the short run...

Apr 10 04:57 PM

[Minlita:]

We were massively oversold so this rally is good but there are financial and economic risks like:
- Deteriorating conditions in major economies
- More unemployment (unemployment in the US is forecast to go to 10%)
- Small or falling earnings (the season is here for 1 month, Alcoa officially oppen earnings season Tuesday after the close and reported a loss of $497 million in the first quarter, not good for a start, the current decline in earnings is several orders of magnitude greater than the average decline during a normal recession )
- Uncertainty over the effectiveness of the government measures

Last week we had some buying on light volume and Monday some sold, it is just like rally during the week leading up to Thanksgiving.

So let's wait and see, it to soon to call for a full recovery

Apr 10 05:10 PM

[Old Trader:]

fatcat,

Unlikely we'll see any shortages at this stage of the game because of over-capacity in almost every sector.


On Apr 10 04:57 PM fatcat wrote:

> Ray,wouldn't a shortage of goods,caused by lack of production,make
> the prices go up...thus inflation...when demand returns? At least
> in the short run...

Apr 10 05:18 PM

[guitoon:]

interesting...I thing you are talking about manufacturing recovery
sure it will recover with the stimulus..but will it be substainable ?? that is the question..economists are starting to talk about double recessions because stimulus will not be enough...

what I am seeking for recovery is
-financial mess clean up : well now we are in the smog as it was required to shut financial big mouths for now on
- real estate bottoming out : still not there...

they are the roots of this debacle so we should look at those first to have a healthy recovery, the rest will be cosmetic or most likely fake recovery

robust recovery ?? that is a joke..driven by what ?? green energies and building bridges ??

Apr 10 08:19 PM

[guitoon:]

interesting...I thing you are talking about manufacturing recovery
sure it will recover with the stimulus..but will it be substainable ?? that is the question..economists are starting to talk about double recessions because stimulus will not be enough...

what I am seeking for recovery is
-financial mess clean up : well now we are in the smog as it was required to shut financial big mouths for now on
- real estate bottoming out : still not there...

they are the roots of this debacle so we should look at those first to have a healthy recovery, the rest will be cosmetic or most likely fake recovery

robust recovery ?? that is a joke..driven by what ?? green energies and building bridges ??

Apr 10 08:19 PM

[Ray Hendon:]

fatcat: I think old trader is right. Price cuts are in order when you have produced too much product,and that describes much of American manufacturing right now. When a recovery begins, that will help manufacturers get back into production and use some of their idle capacity. But, it will be some time before there is any pressure on prices. This will be way down the road.

Best wishes,

Ray

Apr 10 10:45 PM

[Ray Hendon:]

Minlita: I agree with your analysis, that many of the signs are not encouraging. But, I do see some signs that the worst of the real estate price collapse is leveling off, and that many of the hardest hit homes are now being bought by first time buyers and speculators.

But, I don't think the recovery depends on housing prices. A stable real estate market will help, but, in my view, it is not the essential ingredient in a move to recover. We can live with lower house prices if they can be sold and supported by legitimate mortgages. Earlier buyers will take it on the chin, but that is the nature of investing of any time. Sometimes it doesn't pay off.

Also, there are many emerging market economies that are already in a slight recovery. There some basket cases are in Eastern Europe, but the IMF plan for currency intervention has already earmarked huge sums for that region. It would help if Germany would step up and offer some help, since they are the major trading partner of most of Eastern Europe. But, the IMF and
World Bank can bring off a recovery with the help of the other G20 members.

Thanks for you well informed comments.

Best wishes,

Ray

Apr 10 10:59 PM

[Ray Hendon:]

guitoon: I do not think we will have a robust recovery. I agree with you that the credit situation needs to be cleaned up first, and it seems to me to be a long way off. But, other influences are also at work in helping bring us back to a healthier economy. If the stimulus plan does put people to work, that, in itself, will be a big push, and generate much needed payrolls that, in turn, will help stimulate spending.

Yours is a good point as to whether the stimulus is enough. Paul Krugman doesn't think so, and neither do many others. My best guess is that if the current stimulus doesn't produce a self-sustaining surge, then more will be coming soon, and the other measures relating to recapitalizing our banks may get the financial markets back into something resembling sanity. At least, that is my hope.

Best wishes,

Ray

Apr 10 11:06 PM

[dcb:]

I think inflation as a worry exists. I do not trust the fed. You will have inflation period if the dollar starts to loose it's status. It is clear fed policy is to support corporate interests and it has a focus of reflating the credit bubble. add loose credit to a lower dollar and boom. Of course that does mean a double dip when they try the reign in credit and increase interest rates. That may be 5 years down the line and then we may really see the bottom of the market. Of course not likely to be global at that time so the situation may help.

As people use their savings and the is increased unemployement you may find the industrial segment of the market has more to drop. Look at Alco results

Apr 11 05:26 PM

[dcb:]

Hey ray,
thank you for taking the time to respond to comments.

Apr 11 05:27 PM

[chleoku:]

But what about unemployment rate? Look at this graph:

www.wealthalchemist.co.../

Looks like the unemployment curve just started compared to the previous recessions. How would this fit into the ig picture of the recovery?

Apr 11 11:11 PM

[Ray Hendon:]

Chleoke:
Unemployment for this recession is of a different class than of two shown on the chart you suggested. This one is a major downturn--not a temporary dip. Also, unemployment is a lagging indicator. It will be the last thing to turn up, long (months) after the economy and stock market have begun recovering. Once unemployment has recovered to its normal level (4-5%) unemployment, the increased spending resulting from the expanded payrolls will itself propel the economy higher. But, this is the last stage of recovery, not the first. There is a different time-frame for the various stages of recovery. My article has dealt only with the beginning of the beginning.

Best wishes,

Ray


Best wishes,

Ray

Apr 12 12:52 AM

[Alphameister:]

Kudos on an excellent article and equally good replies to comments on your article. I, too, am skeptical that industrial production will recover as dramatically as Professor Beckworth's analysis would suggest, though I hope he's proven right and my skepticism proves misguided. Curious as to whether his analysis would have been predictive during the Thirties. Seems there are quite a few "green shoots" popping up lately.....for the market first and eventually for the economy.

Apr 12 12:51 PM

[Ray Hendon:]

Thank you, Alphameister:
I appreciate your encouragement.

I am also glad the outlook for a recovery is shifting from an unambiguous pessimism to one of at least a mixed outlook. There are some encouraging signs, but there is still tons of bad news that is assaulting us every day.

The questions and comments on this article is the best I can remember. So many people with well informed opinions and questions. My thanks to all who have contributed. Each of you has added important information on a subject that takes arms much longer then mine to completely comprehend and convey. There are so many pieces that fit into a picture of our economic malaise that it would take an army to put it together--or at least that is what all the King's men are trying to do now.

Best Wishes,

Ray

Apr 12 02:52 PM

[Ray Hendon:]

Correction on earlier answer: to Cetin Hakimoglu. My first answer shown. The beginning of the second paragraph read: "I'm not so sure I agree with you that spending will return to negative territory."

I used to word "spending" when I meant to write "savings." I have no rational explanation of how I could commit this bad an error in language. I apologize for the error.

Ray

Apr 12 03:07 PM