Is This Recovery Uncharacteristically Slow?

Includes: DIA, QQQ, SPY
by: Spencer Knight

The recovery from the most recent recession has caused many to feel frustrated and aggravated at the slow growth. Investors have recently faced a new wave of frustration after the Federal Open Market Committee (FOMC) lowered projections for real GDP and raised inflationary estimates.

However, one good data point in the report was a lower projection for unemployment. Curious investors who have not read the meeting minutes can find it here (pdf).

I've come to ponder whether or not the slow pace of the current recovery is good in the long run, or if the slowing recovery is a sign America will not crawl out of this hole. I also question whether or not investors are becoming overzealous in regards to the recent news coming out of Greece. I have contemplated these thoughts because the United States economic recovery has been slowing down, yet investors seem to be flocking to the stock markets like America is booming.

With that said, I must admit I am expecting strong earnings from the major companies this upcoming earnings season and I am not recommending pulling out of the stock market. However, earnings outlooks may not be as strong as companies begin to see the slowdown affect consumers in a negative way.

In my deliberations about the above questions, Wells Capital Management released an investment note titled A Broken or Normal Recovery? This research note provides some interesting facts about the current recovery. The key point is economic recoveries have grown more slowly since about 1985. The main reason for this change in growth is America's labor force has substantially decreased since the mid 1980s.

It is difficult to make comparisons to recessions after 1985 since there have only been three, but the point I will drive home is the fact that the current recovery is not behind previous recoveries. To help prove this, I ask investors to think back to the recoveries from the 1991 and 2001 recessions; and try to remember whether or not you felt worse at that time or now?

While thinking about this, keep in mind we are coming out of "The Great Recession;" therefore the recovery is inevitably going to be difficult. However, if data does not improve over the next 6-10 months we will go through a real "soft patch." I do caution investors to expect bad data every month, but this does not mean the recovery is broken.

As previously mentioned, the drop in the U.S. labor force in the mid 1980s is the main reason for the modern recovery being slow. The national labor force has continued to grow; however it has been at a much slower rate. The data for civilian labor force can be found here or by viewing the graph below.

Roughly the average rate of change of the civilian labor force decreased about 25% during the period from 1985-2011, compared to the rate of change from 1962-1984. These numbers are important because economies cannot crawl out of a recession without substantial job growth.

[Click to enlarge]

In my opinion, the cause for the significant decline in civilian jobs is due to several factors, many of which are controversial and cannot be proven. For instance, outsourcing of jobs is one of the biggest reasons jobs have struggled to continue to rise at the levels seen in the 1960s and 1970s. Many American citizens are upset about outsourcing because these are jobs anybody can do, and the major companies decide to go where labor is cheaper due to a lack of minimum wage laws in other countries. Although this is a smart business move, American citizens suffer. Another reason we saw more growth in the 1960s and 1970s is due to the so called "baby boomers" reaching an age of employment.

Similarly to the labor force numbers, real GDP growth has slumped continuously since 1985. Currently the ratio of real GDP to the level at the end of the recession is the same as 2001 after seven quarters. However, the current recovery is a bit behind the 1991 recovery. This may seem like a good sign, but as the recent data has shown, the recovery is slowing. The slow down in GDP may be a huge bump in the road, but this does not mean the current recovery is broken.

However, if the recovery continues to falter for a sustained period of time, we may see another big dip in the stock market. Another large dip has been made more possible after investors jumped back into the stock market after the Greek austerity votes. With that said, I must reiterate real GDP is not far off the past two recessions. This is important to remember because America crawled out of those recessions very well.

As I showed above, job creation has slowly declined compared to pre-1985 levels. However, when you simply compare the 1991, 2001, and current recoveries the current recovery is better. As you can see in the charts, nonfarm payroll gains are on par with the 1991 recovery percent-wise, and well ahead of the 2001 recovery. Also, private weekly hours worked is well above the 2001 recovery and marginally above the 1991 recovery; when compared as a ratio based upon the current level compared to end of recession levels. This carries positives and negatives. The pros about these numbers are that citizens are working more hours; which puts more money in consumers' hands. However, hiring is not keeping pace with hours worked.

One of the biggest reasons investors are calling this a broken recovery is directly related to consumer confidence. Consumer confidence hit rock bottom levels in 2008 and has slowly increased since then. This is much better than the previous two recoveries as both had overall declines in consumer confidence the following 23 months. However, this may be explained by the fact that it was nearly impossible for consumer confidence to go any lower, therefore it went up. Confidence is important for the stock market because the more positive investors are about the market, the more likely investors will load up on stocks. Inversely, if investors are very pessimistic about the market, we will usually see a decline in share prices across the board.
Another component Wells Capital details is real consumer spending. The charts in the research note show retail sales have been much stronger during the current recovery; compared to levels at the end of the recession. However, this can be explained by the increased price for commodities. The higher prices for raw materials has likely inflated the prices of goods and caused sales and consumer spending to look stronger. I may be wrong, but it appears inflation may play a factor in this.

Furthermore, there is a typical relationship between real GDP and real PCE. Real PCE for the current recovery was on par with the 2001 recovery, until the most recent quarter when data took a dive. This shows, just as GDP, the economy is slowing while the 1991 recovery kept steamrolling along. This does not mean the current recovery is broken as the FOMC is predicting a pick up in GDP the rest of the year; but this increase will still fall short of initial expectations. This is important because it shows the economy is slowly growing in the right direction.

Household obligations and credit card delinquencies are two more data sets that show the current recovery is normal. First off, anytime housing is mentioned while discussing the economy, one must bring up the fact that no matter which way you cut it, the housing market is terrible. Recently much press has been given to the idea that housing prices have fallen below levels of the Great Depression; on a comparative scale. In line with this, residential investment spending and bank loans are well below 1991 and 2001 levels. Along with this, financial obligations are well below 2001 recovery levels and are closing on 1991 levels. Even more impressive, credit card delinquency rates have substantially decreased about 40% the past two years.

This data tells me citizens are focusing more on getting their debts under control before making any major purchases such as a new house. This is a lesson America learned when the housing bubble burst several years ago as many people had bought new homes they could never afford; due in part to banks giving out loans at will.

One reason credit card delinquency rates and obligation ratios could have dropped, may be the fact that banks are beginning to set more restrictions and lower credit lines to keep people from racking up too much debt in a short period of time. Nevertheless, if consumers have less debt, the economy can eventually get rolling again as consumers spend their own money and not a bank's money.

A higher amount of corporate profits is another strong signal the current recovery has potential. As Wells Capital shows, corporate profits have far exceeded profits from the 1991 and 2001 recoveries; although the growth rate has substantially decreased for almost a year.

With that said, the growth rate for corporate profits is still about the same as 1991 and 2001. Corporate profits and consumer investments can clearly be seen by viewing any of the major indexes. I chose the Dow Jones Industrial Average. As you can see, the Dow is heading towards the all time high seen in 2008. This upward momentum is due to consumer investments and corporate profits. These are related because as companies do better, consumers will invest in these companies; which moves the stock market upwards.

However, one must ask the question whether or not this run since the end of the recession is similar to the run leading up to "The Great Recession?" If you look at the run up prior to the 2007-2008 dip in the stock market, we are currently on a very similar path. I must reiterate, I am not saying investing in the stock market is a bad idea, but if the market gets overloaded too quickly, it can lead to unrealistic expectations, which leads to drastic drops that send a ripple through the economy.

On a more positive note, industrial production is much better than the 1991 and 2001 recoveries when compared to the level seen at the end of the previous recession. Before investors can be too happy about that, it must be noted the ISM Manufacturing Purchasing Managers Survey Index has dropped very sharply from month 22-23 after the current recession; which was not seen in the 1991 and 2001 recoveries. While the ISM Manufacturing Index was above the previous two recoveries by a large amount; this is not true anymore.

The above summary of the Wells Capital research note should have brought to mind several questions. The most important question is whether or not this recovery is broken or normal. Also, one must ask whether or not this recovery is simply going through a soft patch just as the previous recoveries suffered. As of now, all we can do is speculate as to whether or not this recovery will turn out just as the previous recoveries did. I personally believe the country will prevail as many measures have been set in place to fix the economy. Many of these measures are often at times blasted by critics saying they will never work; however in the long run the measures will turn the economy around.

Furthermore, investors should take several key points from this research note. First, investors should keep in mind the current recovery is not weaker than historic recoveries; the current recovery simply faces more challenges such as a diminished labor force.

Secondly, the current recovery is a typical recovery for the modern era (post 1985). One of the more important points to keep in mind, is the fact that real GDP will never go above 4%. I say this with conviction because, as Wells Capital showed, GDP has not been above 4% since before the 2001 recession. Another reason I agree GDP will not raise above 4% is because even in the 1990s as the economy boomed, the GDP only averaged about 3.5%. Therefore, unless another unforeseen boom occurs, it will be nearly impossible to reach a 4% GDP rate on a continuous basis ever again.

The above data should do two things: it should ease investors while putting a little fear in their hearts. Investors should feel a little better because the current recovery shows long term potential that should put the previous recession far behind. However, as several signs point to a slowing recovery, investors need to keep in mind if strong earnings are not reported this earnings season, we may see a large drop in the stock market. We will have to wait and see what direction this recovery goes the rest of the year, but it appears we are not in a broken recovery as most people like to think.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.