Lakshman Achuthan: As Economy Throttles Back, So Will Jobs and Earnings Growth

Includes: DIA, QQQ, SPY
by: Harlan Levy

Lakshman Achuthan is managing director of the Economic Cycle Research Institute and managing editor of ECRI's forecasting publications. He frequently appears on CNBC and CNN and is often quoted in the New York Times, Newsweek, and The Economist.

H.L.: What are the implications for the U.S. economy from the latest data?

L.A.: Looking at the coincident indicators of the economy right outside your window, we continue to recover from the “Great Recession,” which ended in June 2009, but the pace of that recovery has begun to slow. While this certainly increases people’s anxiety about the durability of the recovery, it is important to know that such a slowdown is also normal.

Looking at the leading indicators of the economy which correctly anticipated the current slowing, they do not point to a reacceleration, but the good news is that they also aren’t indicating that a new recession is imminent.

H.L.: What do you think of the job gain record and where it’s going?

L.A.: It’s disappointing. Given the more than 8 million jobs that were lost during the recession, we would hope to see hundreds of thousands of jobs created each and every month. Still, we should recognize that while the unemployment rate is unacceptably high, it did peak much sooner following the end of the recession in this recovery than in the prior two recoveries. But as economic growth throttles back, so too will jobs growth.

H.L.: Will the robust corporate earnings keep growing in light of weak consumer demand and so many people out of work?

L.A.: Corporations will almost certainly remain profitable, however, their earnings growth is likely to ease as economic growth softens. It’s not like a new negative, but it’s just a matter of growing slower.

H.L.: What do you think of the Federal Reserve’s deflation concern, as the Fed implied last week, and the effects of lower interest rates?

L.A.: We certainly should question deflation concerns, because it was deflation that was the argument that was used to justify low interest rates in 2003, which many view as the catalyst for the housing bubble, which was at the epicenter of the Great Recession. Still, with inflation virtually nonexistent and the economy now slowing, if a new recession were to take hold, the deflation risk would rise. At this very moment it’s not very risky. If we experience over the coming decade, which is a very long period, a number of back-to-back recessions, then in those circumstances the deflation risk would become material.

H.L.: What’s your take on what has been a surging stock market?

L.A.: Over the summer the double-dip narrative gained a little bit of traction and dragged the market down, as the memory of the Great Recession lingers in people’s minds. Today, with the growing realization that, even though there has not been a strong recovery in jobs, the recession is over, and the market is starting to downplay the risk of a double-dip recession. Many of the questions about where the stock market is headed, where are jobs headed, what’s going on with the budget concerns, all of these issues and questions and concerns come back to the very basic question of whether there is a new recession ahead of us or will we have some sort of a soft landing in growth.

That outcome has yet to be determined, and the best way to judge which fork in the road we’re going to take is to look at the leading indicators, in particular the level of the U.S. Weekly Leading Index, which has remained stable through mid-September. If it continues to firm from here, we will veer away from the recession track and toward a soft landing, which is the outcome most people are hoping for. But I cannot predict where the predictors will go. It is still possible that the Weekly Leading Index will begin a new leg down, If so, the risk of a new recession would mount significantly.

H.L.: The Republicans’ “Pledge to America” calls for cutting spending to 2008 levels except for Social Security, Medicare, and defense, almost the entire federal budget -- with no details on what would be cut, They also want to repeal the health care law, keep the Bush tax cuts, and reduce regulation of business. Can this be done, and what would it do to the economy?

L.A.: With our leading indices continuing to decline, it’s not a time that you want to have policies that tap on the brakes. You might say we can’t raise taxes, because that’s hitting the brakes. Also, on the spending side, now is not the time to reduce spending. If the economic cycle is already heading down, as it is now, you should not be surprised that if you tap on the brakes that things would slow more than you expected, because we’re already slowing.

However, if the weekly leading indicators are firming and going up, and we’re veering away from the recession track, that is a moment in time where tapping on the brakes, if it’s spending cuts, if it’s tax hikes or interest rate hikes, will do less harm, an opportunity to pursue policies that may reduce some of the fiscal extremes that resulted from the Great Recession.

A lot of people say, “I know what is right,” and I’m sure they’re very smart, but what they should add to the debate, which they don’t, is the timing of their actions.

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Disclosure: No positions