Recession or No Recession? That is the Question

Includes: DIA, QQQ, SPY
by: Ron Haruni

Well, the R word (as in recession), factual or not, is here. It started as a whisper not that long ago and its progression from a low, almost muted, word has currently reached confident and sometimes even insistive levels, particularly in the last few weeks by the mass media who in some cases even claimed that the US economy is already well into recessionary stages.

How much validity, however, does the argument of a recessionary US economy, whether from economic observers or the analytical world, truly hold?. In my view, the argument is unjustifiably weak, baseless to the point of being misleading, since the case is not argued in a persuasive, lucid and objective way.

The idea of categorically rejecting the possibility of a non-recession scenario in the first place, followed by the pretension of financial markets signaling a near-term recession, without taking under consideration actual economic data before being conclusive, is quite telling and very puzzling. I have to admit. It is rather difficult to reasonably argue the idea, while excluding the naivety factor that, somehow, so many economic pros, analysts and Wall Street experts espouse; whether expressing their views via airways or by way of writing in favor of a recessionary economic outlook, these experts don't seem to approach the subject objectively.

Why then, the guessing on assumptions and the firm stance of a "game over" type analogy in relation to this economy?! Aren't we conveniently, perhaps, applying into our analysis only the negative aspects of this economy and categorically discounting the positive ones? I do believe that we are since it is not so much what is in these particular analysis, but rather what has been left out.

But, let's focus for a moment here on a counter argument.

I think it is safe to say that since we have heard so much about recession we are confusing recessionary fears for recession. Certainly, the subprime mortgage crisis has been a destabilizing factor for the economy and has contributed as a source for many job cuts and layoffs, especially during the month of August, which according to figures did not help in re-enforcing the perception of a strong and confident economy. Simultaneously, the actual state of the financial sector and its vulnerability as a result of the subprime debacle at first glance makes the economy without question look rather shaky.

However, if we are to partially accept the hypothesis of the recession theory - which is that of being accelerated mostly by an increase in job losses, subsequently allowing the possibility of a rippling effect on the economy therefore, creating favorable conditions for a recession to take place - then, to think that a change of about 100k jobs to the negative side, having devastating implications inside a giant economy such as ours, with millions and millions of jobs, is not only insignificant to the economy as a whole, but will most certainly not justify the aspect of such conditions signaling the existence of recession or the possibility of a near-term one.

The other factor behind the claim of the pessimistic crowd, justifying the argument of the current economy headed if not already in recession, is that of the GDP growth slowing down to an annualized pace of just 1.5% in the current quarter. Rightly so, the argument can be made of two or more consecutive quarter slow down constituting grounds for recession. However, this specific detail, while valid, is open to different interpretations within the broader definition of the recession theme. This specific analytical factor is only part of the equation and does not necessarily constitute, nor verify with certainty, the presence of deteriorating conditions in the current economy to subsequently prompt it recessionary.

Moreover, there can be serious declines in economic activity even without two consecutive quarters of negative growth. Another approach to be considered before reaching recession conclusions, is that of taking into account different dimensions of the decline in aggregate economic activity including depth, duration and diffusion across industries. I believe that the definition of recession is quite broad and guessing on assumptions is one thing. Being conclusive is what's required to bring us to the next question.

Are market conditions such to suggest that the actual economy is only capable of generating negative news?

I would strongly disagree with the premise on the basis of economic verifiable data proving otherwise.

The economy boomed in Q307 despite the problems created by the credit market. Only at the beginning of this month, personal income and spending showed signs of continued growth by posting a 5.6% increase over the last 12 months. This was prompted by 6.8% rise in personal income over the last year. Since August of fiscal ' 03, 8.31 million jobs have been created, with 1.68 million jobs created over the 12 months that ended in October of current fiscal '07. This economy has now added jobs for 50 straight months - the longest period of uninterrupted job growth on record.

According to only recent reports, disposable income is at its highest levels since Q1 of fiscal '05 and growing, currently at 4% levels. Real GDP in Q3 was upwardly revised to show 4.9% annual rate growth, versus the 3.9% originally reported. We also had the largest upward revisions in inventories, adding one full point to real GDP growth rather than the original estimate of 0.4. The GDP price index rose at a 0.9% rate in Q3 of current fiscal, up 2.4% versus last year.

I understand the inclination in opposing the argument of the current growth already behind us, but not so fast oversimplifying it. Let's take a look at the nominal GDP growth. It has reached an annual rate of 5.8% in the last three quarters, against a nominal of only 4% during housing related slowdown between Q3/ fiscal '06 and Q1 of fiscal '07.

This type of acceleration in nominal growth is very significant while consistent since it will not happen when the Federal Reserve is tight. Additionally, corporate profits are up 2.7% versus a year ago with businesses still with more than $1 trillion cash in hand. For the next year, after-tax corporate profit are projected to grow about 5%. Current annual rate of labor compensation is running at $475 billion higher than the last year, recording the largest gain in history. Our major corporations and financial institutions appear strong, with fairly solid balance sheets. S&P 500 aggregate earnings are projected to grow at 7.4% pace into fiscal '08.

These numbers project purchasing power on the part of the businesses and consumers. There is no contraction of the money supply here, suggesting strong growth ahead rather then weakness.

My view is that it is going to take a lot more than just layoffs and one underperforming sector to push our economy into negative territories. Let's not forget Savings & Loans, our nation's largest-ever financial scandal recording 1456 bank failures between fiscal 1982 - 1993. Yet, the overall economy performed quite well during that time with GDP numbers posting above average rates and no recession.

I believe that fiscal '08 will be a growth story for the stock market. The credit situation, though not formidable, is still functioning reasonably well. As long as the Fed remains focused and firmly behind this economy, doing whatever it can to keep it moving forward by aggressively applying rate cuts when needed, overall our system of production, distribution and consumption will continue to remain mostly on upswing and immune from any direct recessionary hits.