John Hussman: Enter, The Blindside Recession

by: John Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (6/25/12):

In recent months, our measures of leading economic pressures have indicated the likelihood of an oncoming U.S. recession. Our view is based on the analysis of leading/coincident/lagging indicators (see Leading Indicators and the Risk of a Blindside Recession) as well as more statistical signal processing methods that extract "unobserved components" from noisy data (see the note on extracting economic signals in Do I Feel Lucky?). As Lakshman Achuthan at the ECRI has noted on the basis of different but related evidence, the verdict has been in for a while. The interim has been little more than waiting for the coincident data to catch up to the leading evidence that is already in place.

This wait is by no means over. As Achuthan has observed, economic data such as GDP and employment data are heavily revised over time. Very often, the first real-time negative GDP print occurs about two quarters after the recession actually begins. It is only later that the data are revised to show an earlier downturn. For that reason, it's important to pay attention to the joint action of numerous economic data points, rather than selecting any specific indicator as an "acid test." The joint evidence suggests that the U.S. economy has entered a recession that will later be marked as having started here and now.

The following chart shows the most leading economic component (blue) that we infer from a broad composite of economic indicators. This component has a lead of several months, relative to broadly observed economic data. Importantly, even the observable data has now predictably turned down, as evidenced for example by the "surprising" weakness in the Philly Fed data last week. We expect further weakening in employment data, coupled with an abrupt dropoff in industrial production and new orders.

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The weak estimated response of GDP to quantitative easing is close to the estimate I offered in November 2010, which suggested a temporary bump to GDP growth of about half of one percent. Contrary to Ben Bernanke's assertions, the notion that provoking stock market speculation significantly helps the economy via "wealth effects" has no theoretical basis (as Milton Friedman and Franco Modigliani demonstrated decades ago, consumers base decisions on their "permanent income", not transitory fluctuations, and boosting the asset price does nothing to change the underlying stream of cash flows), nor any empirical basis (economic studies consistently show that a 1% change in market value affects GDP growth in the same year by only 0.03% to 0.05%, and even that effect is transitory).

We can't rule out further attempts at monetary heroism from the Fed, and as I've emphasized in recent months, an improvement in our own measures of market action could allow some latitude to accept a modestly constructive stance, regardless of valuations or recession concerns. Nevertheless, investors should recognize that monetary interventions would largely be a device to provoke speculation and to counteract risk aversion in the financial markets, with very weak effects on the real economy. It's true that in 2010 and 2011, one or two quarters of support for GDP growth was enough to push off emerging economic weakness for a while. At present, the economic headwinds are much more serious, particularly given European strains. So aside from the hope for transitory speculative benefits, it's not at all clear that further quantitative easing would be effective in halting a U.S. recession that, by our estimates, has already begun.