How Strong Will the Recovery Be?

"The deeper the slump, the zippier the recovery."

That is James Grant's judgment in a nutshell. The conclusion surprised me, not because I disagree, but because I'm used to Grant being pretty bearish. His Wall Street Journal article is illustrated with photos of Roosevelt, Greenspan and Buffett (not Jimmy), as well as cute animals. No wonder the paper is losing money. His conclusion cries out for a simple chart. Let's look at the data!

Here it is. The peak-to-trough change in GDP is shown on the vertical axis. The growth over the following four quarters is on the horizontal axis.

Note: if the current recession troughed in the second quarter of this year at a level equal to the preliminary estimate, then our peak to trough is about minus 3.7 percent, right there at the bottom of the chart. Imagine a line through the points, and you find this recovery at about 11 percent.

This ain't science, and I wouldn't make a forecast using this methodology. However, it leads me to wonder if I'm being much too conservative in my own economic forecast.

A final note on the data: the sharp readers are wondering how one recession showed positive GDP growth. That was 2001, a fairly mild recession. The actual cycles are set using monthly data, then we do GDP studies by grabbing the quarters that contain the peak and the trough. For a short, mild cycle, it's possible to get weird quarterly numbers.

Comments

[Vuke:]

Well, Dr. Bill, it may be a doozer of a recovery.

We'll have every lawyer in the country knee deep in lawsuits, bankruptcy courts and auctioneers running full tilt, carpenters building windmills everywhere and the last few real mechanics trying their best to keep old autos running. In the midst of this will be bevies of politicians, consultants, media hacks, lobbyists and financial product designers waving their arms and proposing schemes.

The GNP should pop up 11% in no time. Imports will flow, markets and mortgages will rise and we'll be back to the "good old days" in no time.

Sep 23 06:20 AM

[markfl:]

These types of scatter plots and economic debate have drawn attention on a few Fed Regional Bank blogs. There are two problems. 1. The central tendency of private forecasts is around 3 percent. Not terrible, but not great. 2. The contraction in employment as been a far sharper negatively than the gdp contraction. In previous recessions--even short but sharp contractions--firings and job growth generally correlated with the severity of the recession and strength of recovery. The fact that the recessionary phase has showed a steeper than expected employment trough causes many to question whether gdp recovery will mirror the downward leg of the "V." This is one sound theory behind the "L" or "U" concept: steep contraction + steepER job losses equals modest gdp recovery and weakER (than normal) job creation.

Sep 23 07:06 AM

[chap08:]

The less pithy way of saying it is to quote Michael T. Darda, chief economist of MKM Partners, Greenwich, Conn.: "[T]he most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period."

If there are no exceptions, then to say that this recovery will be weak is to say "it's different this time". Well, as we know, those are "the four most expensive words in history". I don't like expensive mistakes so I pay attention to history, but I also believe that, to an extent, it is different this time.

It is hard to look at our twin deficits, lack of cheap oil, debt levels and lack of international competitiveness, and then to say "we've been there before".

Sep 23 07:32 AM

[Mad Hedge F...:]

bio Reviewing the current political and monetary landscape, I would be remiss, irresponsible, even negligent, if I didn’t revisit one of my favorite ETF’s, the Proshares Ultra Short Treasury Trust (TBT). This is the 200% leveraged bet that long Treasury bonds, the world’s most overvalued asset, are going to go down. While the Fed is going to keep short rates low for the indefinite future, it has absolutely no direct control over long rates. The only political certainty we can count on it the continued exponential growth in the supply of government bonds of all maturities. Like all Ponzi schemes, their eventual collapse is just a matter of time. It’s simple a question of how many greater fools are out there (sorry China). Look at how they are trading now. We currently have the greatest liquidity driven market of all time, and the ten year is only eking out a 3.40% yield, pricing in near zero inflationary expectations. The average yield on this paper for the last ten years is 6.20%, a double from the current level. Get the yield back up to 5%, a distinct possibility in 2010, and that takes the TBT from the current $45 to $70. Sure we may get a sideways grind in yields for a few months, which will be expensive due to the mathematic idiosyncrasies of the 2X ETFS. But a security that is unchanged if I am wrong, and doubles if I am right is the kind of risk/reward ratio that I will take all day. And I believe that in my lifetime Treasuries may lose their vaunted triple “A” rating and be priced closer to subprime (warning: I am old). That could enable the TBT to deliver the holy grail of trades, your proverbial ten bagger.

Sep 23 02:15 PM