If It Looks, Walks and Quacks Like a Recession...

If it looks like a duck, walks like a duck, and quacks like a duck, well my friends, it's a duck. I think the same can be said about a recession. Even though our friends down at the National Bureau of Economic Research aren't saying it yet, I'll go ahead and go on record... I think we're already in a recession. (Insert gasp here.)

Before you start cursing at me or stick your head in the oven, let me also say that this isn't inherently a reason to sell stocks. Well, it might be a reason so sell some stocks, but I think it could be a reason to buy other stocks. More on that in a second.

So what data do I use to indicate a recession is walking among us? I actually use a combination of four criteria - none of which is GDP. My best 'tells' are inflation, the Fed Funds rate, unemployment, and capacity utilization. While their current status doesn't absolutely, positively say the 'R' word, the odds certainly say the economy is struggling to stay afloat.

The chart below really tells the tale. Previous recessions - as defined by the National Bureau of Economic Research - are highlighted in red.

I've over-laid the inflation rate, the Fed Funds rate, and the unemployment rate all on the same middle plot so we could really see how all three relate to one another...particularly when we're in what the NBER defines as a recession.

The bottom plot tracks capacity utilization data, which can't effectively be placed on the same plot with inflation and the other data.

The reason I believe we're already in a recession now is simply that the four key pieces of data I worry about are mostly doing the same things they did before, during, and after the prior recessionary periods.

Specifically, inflation is now on the way up. Capacity utilization is starting to point lower too. The Fed Funds rate? Also headed lower. That often surprises a lot of investors, as the move is supposed to stimulate the economy, and send stocks along for the ride. My only comment is rhetorical question...do you think the Fed is pulling out all the stops because the economy is healthy? The Fed is desperate here, and the more desperate they are, the sharper the decline in interest rates. And finally, inflation is headed higher. If the fed keeps cutting rates, inflation could swell even more.

If you look back to the prior recessions, you pretty much see the same thing. Yes, you'll see individual instances for the four criteria where they're falling or rising like they are now, but not as part of a recession. However, you rarely see ALL FOUR simultaneously doing what they're doing now without a recession.

S&P 500 (Monthly), with key economic indicators
click to enlarge

So why is nobody coming out and saying this? Maybe there are political ramifications. Maybe the powers that be don't want to start a fire-sale. Maybe they just don't want to believe it either. I really don't know. And frankly, I really can't worry about it - I just have to do what I think is the right thing for my portfolio.

And what is the right thing in a recession? The standards still apply - tobacco, staples, energy, healthcare, defense, and other arenas that don't suffer when consumers aren't in the best of moods. Nothing fancy about any of those themes.

With all that being said, I did want to point out two key ideas that are just as important as my recession pep-talk. (1) Stocks tend to start a recovery well before the recession is technically over. (2) Recessions are usually short-lived...relatively speaking.

In other words, don't freak out. If you're holding vulnerable stocks, yeah, it might be wise to pare them. If you're holding quality names, you might end up being more unscathed than you think (particularly if you lean towards the sectors I mentioned a moment ago).

Nevertheless, I feel a recession is here, and I think it's too late to nip it in the bud. That's not a bad thing necessarily, but I do think it changes how the game is played.

Comments

[Big Fat Meanie:]

Good analysis--I was thinking along many of the same lines as you expressed.

One thing I've noted from pundits is that they consider the current unemployment rate of 5% as in line with the natural rate. Indeed, by historical standards, 5% is quite low; most of the 70s, 80s, and 90s were marked by higher average unemployment rates. However, the dynamics of the modern economy actually make the 5% unemployment rate less bearable than in the past. Higher levels of indebtedness and lower savings rates make unemployment more hazardous, while the permanent departure of many of the better paying blue collar jobs have displaced a fair number of potential workers.

2008 Jan 25 10:45 AM

[Hooligan1:]

Sure recession is here, we are in the big R territory. However, wait until our elected representatives, all of them, get through trying to fix it. Then we will see what I have experienced and just as soon not experience it again: -- the big D!

2008 Jan 25 03:35 PM

[James Brumley:]

Big Fat Meanie,

Yep, the unemployment analysis is a whole 'nother ball of wax. I didn't touch on it here, but I have observed that there is no 'ideal' unemployment. The only thing that matters (to investors) is the direction of the trend. (e.g. the unemployment rate falling from 18% to 17% is good for stocks, even if still astronomically high by historical measures).

As for the 5% rate now being more of a real burden than say 5% from the 80's, while I never thought about that, I think I agree. Good point. Maybe I'll be able to cross reference unemployment and debt in a future commentary. Thanks for bringing it up.

Hooligan,

I hear that. The more they tinker, the worse it seems to get.

2008 Jan 25 04:37 PM

[gordon:]

Yes, unemployment is 8-10%. The BLS should be investigated for it's use of birth-death phantom jobs, they are STILL ADDING FINANCIAL JOBS, same amount as the previous years! We actually LOST over 330,000 jobs last report. The weekly unemployment claims are a fraud using seasonal adjustments 2 reports ago the total clains climbed by 26K yet they said it was down 18K Prison inmates are counted as manufacturing jobs, as it fast food.
The GDP is a (criminal?) fraud because the CPI imput is a fraud, in the last report they used a GDP deflator that was the lowest inflation in 43 years.(source:financia... They have taken hedonic indexing and substitution to levels never seen. Clinton /Greenspan expanded on this, Hillary should be asked if she will investigate the BLS. Bush -Rove installed a political operative in every agency to monitor all releases, who and how many in the BLS? Inflation is 8% incl food & energy, which are now permanent costs due to war, supply and ethanol fraud, which uses nat gas we need for other things.

2008 Jan 26 04:56 PM

[Old Style:]

I don't have any real economic knowledge or political insights, but from what I put together from readings over the last several months, is that this is no ordinary recession. It may indeed be the normal business cycle timing for a recession, but many seem to be overlooking that it is coinciding with a "coming to a head" of years of financial irresponsibility by the government(s) and by the consumer.

When I read, as in this article, that recessions are "short-lived" and stocks rise even rise sooner than their "short" duration, I begin thinking that this particular recession is being minimized to the max. Head in the sand, wishful thinking?

Years of deficit financing by governments and consumers, along with simple unmonitored money grubbing by financial "professionals," is likely going to take a few years to unwind, even when assisted by printing more paper money to inflate currencies, in order to pay off debt in cheaper dollars, euros, etc. Unless I've missed some new notification, there is still no free lunch, so I figure it has come to time to pay the piper. If nothing else, through the eroding value of the dollars in our pockets, savings accounts, 401Ks, IRAs. Yup, even those of us who have saved our money and are not in debt, are going to be tapped to pay off this debt.

Seems to me that our collective greed and avarice has dug us into a very deep collective hole. I don't see this recession being short, I see it being protracted and very painful. Am I missing something? I would sure like someone to shoot down my comments, as I would love to become more positive about this! Please show me where I'm wrong!

2008 Jan 26 09:13 PM

[gordon:]

If you need more proof of a corrupt (criminal?)BLS ,per my previous post, HERE YOU GO. How is the BLS able to take their CRUDE OIL SAMPLE FOR THE PPI the day after THE LOWEST PRICES OF EVERY MONTH?!!!!!! anyone?
www.financialsense.com...

2008 Jan 26 10:41 PM

[James Brumley:]

Let's see....where to begin? How about the beginning?

WakeUp, yeah - the unemployment figures may be meaningless and 'tweaked' for optimism. However, that's not new. We just have no feasible way to know just how trumped the historic numbers were as well. That's why I said (though not emphatically enough) the absolute level of unemployment means nothing to me or you. The only thing I have any faith in is the direction of the trend. (e.g. if unemployment rises from 5% to 6%, it's the same effect as rising from 10% to 12%.)

Gordon, I don't know that the GDP is fraudulent, but I do know it's worthless to investors. So, fraudulent or not, I don't even care. As for a BLS investigation, I don't see it happenin'.

Old Style, well said. I still feel a recession will be minimized, as the Fed only seems interested in short-term patches (3 to 12 months). Should the recession last longer? Yes, I think so. A good, long, normal recession would burn off a lot of excess...a much needed does of good medicine. I suspect we'll only get the short-term fix though.

Will Rahal, thanks for the chart. Good stuff.

2008 Jan 28 10:24 AM