A Consumer (Not Industrial) Based Recession

Includes: DIA, QQQ, SPY
by: John Orr

Everyone wants to know, everyone feels like they need to know: Are we in a recession? Are we headed for one? Most importantly, how bad will it be?

We would like to delve a little into what economic numbers are best at predicting and forecasting a recession. The actual numbers, details, and percentages that were given in these 7 economics reports aren’t as important as the prediction we are going to make about what they mean.

There are 7 economic indicators that are considered to be the most reliable predictors of an economic recession. Below is listed the Indicator and their next report date.

  • Job Growth: March 7
  • Manufacturing [ISM]: March 3
  • Consumer Confidence: February 26
  • Leading Indicators: February 21
  • Inflation[CPI]: February 20
  • Industrial Production: February 15
  • Retail Sales: February 13

Below is a list and description of the last report for each of the indicators and the summary of that report.

Job Growth – 17,000 jobs were trimmed in January. Along with a population adjustment, the national unemployment rate rose to 4.9%. The problem doesn’t seem to be that firms are firing, but that they are reluctant to hire until they see what economic 2008 has in store for the U.S.

Manufacturing [ISM] – The institute for supply management released January numbers of 50.7 compared with 47.7 for December. The numbers are weighted around 50; greater meaning an expansion in manufacturing. The results are consistent with slow growth, but that’s still growth.

Consumer Confidence – This is a valuable indicator. Turns out the consumer knows what they want. A reading of 87 was expected, January’s number was 87.9. This indicated that the consumer is NOT confident in the economy. Their number 1 complaint, they expect employment to deteriorate.

Leading Indicators – This is the basket of all indicators. It includes numbers for: new orders, jobless claims, money supply, average workweek, new home permits, stock prices, etc… December shows the third straight negative month, but at least we are going in the right direction. October fell 0.5%, November fell 0.4%, and December fell 0.2%.

Inflation – As measured by the consumer price index, inflation rose 0.3% for December and 4.1% for the last 12 months. This was the highest rate since 1990 and an increase from the 2.8% in 2007. The importance of this number is that it is higher than the 1%-2% that the Fed would like core CPI to stay between.

Industrial Production – While this number came from the Philadelphia Fed, it is usually thought to be a good measuring stick for the entire U.S. economy. New Orders showed their first negative number in 15 months, but since this number is a precursor to ISM (which showed positive results) we can interpret a slow growth situation.

Retail Sales – Holiday sales are approximately 50% of sales and profits for retailers, and consumer spending is thought to be 2/3 of the economy. Yes, this number is important. November and December sales rose only 3%, analyst were looking for 4% says the National Retail Federation. This was the lowest number in 6 years (since the last mini recession).

Things to Remember

1. A recession must last 6 months to be called a recession.

2. Stock markets are forward lookers, they are often concerned about what is going to happen, not what is happening. This is why earnings forecasts are often more important than the earning numbers themselves.

3. Stock prices typically bottom two to three months before the recession is over.

4. There is more than one sector to the capital markets; some can experience growth while others experience recession.

What we can gather from the last 7 economic reports that have come out is that industrial production and manufacturing is rebounding, and consumer confidence and retail sales are weak. The economy has been in a recession, as evidenced by the weak or negative growth, but the results seem to be turning around or easing in certain sectors. This supports our conclusion that the economy is in a consumer recession, but industrials and manufacturing were simply weak and improving.

So what are we in for in the future? We like to take a 6 – 10 month outlook, and there seems to be signs of help. The Dow is trading at around 13 p/e, stocks seem to be undervalued due to an overreaction to financial and housing problems (I’m not saying we didn’t have any problems), and we have help. What kind of help? The three B’s.

  • Bernanke – Fed chief has lowered rates 1.25% in the last three weeks. This is aimed at helping consumers afford their adjustable rate mortgages and helping banks greatly improve their balance sheets.
  • Buffett – Warren announced today his offer to take over the municipal bond insuring of three major mono-line insurers. No, this doesn’t solve any problems; and No I don’t think they should accept his offer, but the point is, there are people willing to help out these troubled companies when times get tough (not just helping, he will make $$$)
  • Bush – The president signed the $150 billion economic stimulus package Wednesday. This will put $600 into the hands of most Americans which offers a short term solution to the problem. The real gem of the congress approved package is the tax bonus for businesses to try and stimulate corporate spending, and it will.

None of these solutions alone will be the savior of the U.S. economy, but all together, along with a resilient consumer and economy, the outlook for a bright second half of 2008 is looking even rosier.