Is the Recession Finally Ending? I'm Hopeful but Not Convinced

Includes: DIA, QQQ, SPY
by: Bob McTeer

A Technical Answer

The Business Cycle Dating Committee (BCDC) of the National Bureau of Economic Analysis determined that the current recession began when payroll employment started declining in January 2008. I doubt that they will declare the recession over while payrolls continue to decline, even if we get positive GDP growth in the current quarter, especially if the growth results primarily from an inventory rebound and one-time clunker rebates.

My assessment differs from many talking heads who have gotten used to the idea of a "jobless recovery" based on experience of the last two recessions. Many of them have declared the recession over already, expecting a positive third quarter GDP number, even though they expect employment to decline for several more months. However, I think they've misread recent history.

The BCDC declared the last recession over in November 2001. Employment then grew for a few more months before turning negative again, giving rise to the "jobless recovery" handle. My point is that the BCDC didn't declare the recession over while employment was still falling. Employment resumed falling after the recession end had been called. If they had delayed their pronouncement a few months, I doubt that they would have been pegged it as the end month.

Recent declines in payrolls have moderated, but are still large in historical context. Furthermore, the unemployment rate is likely to resume its rise--it declined from 9.5 percent to 9.4 percent in July--because the household survey, which determines the unemployment rate, has some catching up to do relative to the establishment survey, and also because the recent improvement resulted primarily from a shrinkage in the labor force that is likely to reverse when job prospects pick up.

An Answer from the Gut

The improvement in the real GDP estimate from minus 6.4 percent in the first quarter to minus only 1 percent in the second quarter was impressive. The decline in inventories contributed 0.8 percent of the 1 percent decline in real GDP. That plus the inventory decline in the previous quarter sets the economy up for a significant inventory rebound in the current, third quarter. GDP would be boosted in a technical sense, but not, in my opinion, in a fundamental lasting way.

Besides inventories, residential and nonresidential construction are also part of investment, and they don't seem poised to rebound soon. Smaller declines, however, will help some.

The foreign trade sector is unlikely to contribute a lot more to expansion, but that is difficult to analyze these days. In the second quarter, a small decline in exports reduced the GDP number while a larger decline in imports increased them. Without a resumption of dollar depreciation, it's hard to see much more help coming from net exports.

Note that both exports and imports have declined recently, but imports declined more, suggesting a weak U.S. economy relative to our trading partners. The predominant influencer of our imports is our own economy, and a large decline in imports reflects weakness in domestic demand. Our exports respond primarily to foreign demand, which presumably wasn't as weak as ours. We already knew that was the case in several Asian countries, but we were recently surprised that France and Germany also rebounded before the U.S. economy.

The idea that we went into the recession first so we will come out of it first never was based on any logic that I know of. More to the point, in my view, is that while we exported much of our toxic sub-prime laden MBSs we probably consumed more of them domestically. If you call it food poisoning, we consumed more of the poison fruit.

Parenthetically, the decline in both imports and exports is common around the world as the recession takes its toll on foreign trade. A worldwide decline in trade is an ominous trend that is negative by itself, but also sets the stage for destructive protectionist beggar my neighbor policies, some of which we've already seen - indeed some of which we initiated.

I'm skeptical that a sustainable recovery is at hand because of the headwinds facing the consumer, and what Keynes called the Paradox of Thrift. That paradox is that if consumers in general try to save more, incomes will decline and less will be saved out of the smaller incomes. For our purposes, if consumers successfully save considerably more, which they need to do individually, it will reduce consumption (70 percent of total spending) and make the recession worse. We are no longer in a situation where consumers don't have to save because of their appreciating 401Ks and houses. Those easy days are over.

We recently had a short period that got a lot of publicity where consumers saved more and their incomes rose at the same time. It's possible to do that if incomes are boosted enough. In this case, it was the extra checks to lower-income social security recipients associated with the stimulus program. That's a one-time deal, or at least not permanent.

The bleak prospects for consumer spending going forward can't be good for investment spending, which depends ultimately on consumer demand. So it's hard to see where sustainable spending strength will come from. However, these factors didn't prevent a significant improvement from the first to the second quarter. So, hopefully, I'm wrong.

One possibility is that the factors I've cited above won't prevent a recovery, but will just make the recovery weaker than normal.

One caveat: Even if my pessimism on the economy is borne out, that doesn't necessarily mean the stock market can't do well. Stocks are a leading indicator that can look far ahead, and they have a lot of catching up to do.