John Hussman: Not Yet Out of the Woods

by: John Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (9/27/10):

In its release, the Committee noted that it "places particular emphasis on measures that refer to the total economy rather than to particular sectors." These include "a measure of monthly GDP that has been developed by the private forecasting firm Macroeconomic Advisers," and "measures of monthly GDP and GDI that have been developed by two members of the committee in independent research (James Stock and Mark Watson)."

The Committee generously provides downloadable data on these measures, which make for fascinating research. In particular, a review of that data suggests that the NBER may have to deal with the prospect of a "future downturn of the economy" much sooner than any of us would like.

Below, I've plotted the smoothed quarterly and 6-month growth rates of the Stock and Watson monthly GDP measure cited by the Committee, following the method of Zarnowitz and Moore (see last week's update). The data is through June 2010. Note that the plunge in the smoothed growth rates occurred because even though GDP growth was positive for the second quarter, there was a sharp downturn in the monthly figures, which a variety of indicators also picked up (such as the ECRI Weekly Leading Index), and has unfortunately continued into the present quarter.

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Though the Stock and Watson data has a longer history, the same downturn can be observed in the Macroeconomic Advisors data.

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Below, I've combined the long-term Stock and Watson data with the ECRI Weekly Leading Index growth rate to give a picture of how fluctuations in these measures have correlated with past recessions (shaded orange) identified by the NBER. Given the upward spike in growth that we observed in mid-2009, the choice of a June 2009 turning point is consistent with historical precedent. The Committee typically dates the beginning of a recovery at the point where the growth rates of underlying measures of economic growth clearly spike from negative to positive. What is of immediate concern though, is the trajectory that growth rates have taken since then.

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Again, the graph presented here is as of June 30, 2010. While we know the ECRI data has deteriorated further since June, we won't have GDP figures for a while yet. Given the data in hand, it's clear that past growth downturns of the same extent have often gone on to become recessions. However, there are a few exceptions where these growth rates dipped below zero and then recovered. If we had good reason to expect positive economic tailwinds, we would be less concerned about the present deterioration. Unfortunately, my impression is that the bulk of the growth that we did observe coming off of the June 2009 economic low was driven by a burst of stimulus spending coupled with a variety of programs to pull economic activity forward. My concern is that these synthetic factors are now trailing off, with little intrinsic economic activity to carry a recovery forward.

Suffice it to say that we're not yet out of the woods.