In recent days, market watchers from Bill Gross to Morgan Stanley have warned of the high possibility of a double dip recession for reasons ranging from more regulation and “policy errors,” to slowing consumption, weak economic data and the likelihood of further fiscal tightening.
While I do believe that the odds of a double dip have risen since the S&P downgrade of US debt, I still think the most likely outcome is a sluggish recovery, not another recession.
What’s my evidence? Leading indicators and retail sales data in the US and abroad.
Yes, virtually every economic indicator has dipped in recent months. But few are signaling a return to a 2008 style recession. In fact, major leading indicators that predict US gross domestic product (GDP) still suggest sluggish US growth and that the two-year-old expansion should continue.
Take the most well known measure — the Conference Board’s Leading Index. The measure has increased in 11 out of the past 12 months, including a better-than-expected reading last Thursday. In contrast, in the year leading up to September 2008, the indicator rose on only one occasion.
Perhaps more relevant is the recent behavior of two lesser known indicators, the ISM New Orders component and the Chicago Fed’s National Activity Index (CFNAI). Both measures may provide a good prediction of next quarter’s US GDP — historically you can explain roughly 45% of the variation in next quarter’s GDP by watching the level of the CFNAI.
Currently, both indicators are weak, but they are still signaling positive growth of around 2% next quarter. This is in marked contrast to the situation heading into September 2008. Along with other leading indicators, the CFNAI started to slide in 2007. By the eve of the Lehman bankruptcy in September of 2008, the indicator was signaling a severe economic contraction.
Similar leading indicator measures in Europe also don’t suggest a significant contraction in the third quarter. For instance, the most recent IFO Survey — a business climate indicator with a good record of forecasting European GDP — has fallen modestly from its February all-time-high but still indicates growth.
Apart from leading indicators, retail figures – at least as of July – provide evidence that consumers continued to spend. July’s US retail sales numbers showed a gain of 0.60% on spending, stripping out food and autos. There also have been signs of healthy consumer demand in most emerging markets. In Brazil, retail sales recently grew by over 7% from one year ago, well above expectations. In China, retail sales have been growing steadily at around 17% year-over-year for the past several months.
You can read more about my take on double dip and recent market activity in my latest Market Update piece.