In an interview with Bloomberg this week, Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) reaffirmed the recession call that was first made in late 2011, indicating that they believe the US has entered a recession as of the second quarter of 2012.
It has been almost a year since we predicted a recession. Back in December, we went on to specify the time frame for it to begin: if not by the first quarter of the year, then by mid-2012. But we also said at the time that the recession would not be evident before the end of the year. In other words, nine months ago we knew that, sitting here today, most people probably would not realize that we are in recession - and we do believe we are in recession.
Think back to four years ago in 2008, a couple of days before the Lehman failure. Looking at the data in hand, you would see GDP growth at about 1% in Q1 and 3% in Q2. More specifically, Q2 GDP growth had just been revised up on August 28 from 1.9% to 3.3%, sparking a 212-point Dow rally that day. In an interview featured in a recent issue of Bloomberg Businessweek Chairman Greenspan was asked whether anything during the financial crisis had changed his worldview the way Ayn Rand had decades ago. He said, "Yes, of course," recalling the day before the Lehman collapse when he had said that recession was probably coming - not that it was already nine months old. At the time, he was far from alone in his view. When asked if that mistake had been humbling, he replied, "Indeed."
In our experience, too, monitoring business cycles is often humbling. In March 2001, 95% of economists thought there would not be a recession, but one had already begun. And we do not recall anyone outside our shop predicting the 1990-91 recession beforehand. Hardly any economists recognized the severe 1973-75 recession until almost a year after it started. Indeed, that recession began with the ISM at 68.1, and payroll jobs growth did not turn negative for eight months. In 1970, unaware that the economy was nine months into recession, none other than Paul Samuelson said that the NBER had worked itself out of a job, meaning that improved policy expertise had made recessions very unlikely. The key point here is that it is really difficult to know that a recession has already begun - until long after the fact.
But what data supports our recession call? We just discussed what GDP had looked like four years ago. Please note that for each of those two quarters GDP growth has since been revised down by two to three percentage points. Those are huge revisions. Likewise, GDP growth prints for each of the first two quarters of the two prior recessions were revised by about two to four percentage points. The takeaway is that, in the early stages of recession, the data are almost always revised down, and the revisions tend to be quite substantial near business cycle turning points. Knowing this, how should we feel about the current GDP estimates that average less than a 2% pace for the first half of 2012, i.e., weaker than first-half GDP growth looked four years ago? Please remember, by that time, in September 2008, the economy had already spent nine months in recession.
In the current cycle retail sales have already peaked back in March 2012 and, according to the household survey, employment has declined for the last two months, and for four of the last six months. Mind you, the household data is revised a lot less than the payroll jobs data and also tends to lead it a bit at cycle turns. (While the jobless rate, calculated from the same data, is yet to turn up in this cycle, that is mostly due to people dropping out of the labor force.) Since July, when we highlighted the weakness in personal income growth, there have been revisions showing even weaker income growth going back a few months, followed by some apparent recovery recently. As with some of the other coincident data, this series will come under significant revision in the months (and years) ahead. Nevertheless, the weakness in income growth is showing through in retail sales data, which, as mentioned, has actually declined since March.
Many point to the stock market being at new highs as evidence that there is no recession. But as people have learned over time, the market is not just about the economy. That is one reason we forecast business and inflation cycles around the world, but we do not make market calls. Consider the facts. In three of the last 15 recessions - specifically, in 1980, 1945, and 1926-27 during the Roaring Twenties - stock prices remained in a cyclical upturn. Of course, in 80% of those 15 recessions there were cyclical downturns in stock prices. So, while recession does mean high risk for equities, it does not guarantee a stock price downturn. Then there is the worst recession in the last 100 years, when stock prices peaked only after the recession began in August 1929. No doubt, equities have done well in recent months, but is that because of the economy's strength, or is it about central banks?
While the new U.S. recession is ECRI's most high-profile call, we have made a number of other key forecasts this year. In April, we predicted an upturn in U.S. home price inflation, as well as a downturn in global industrial growth - and we have been consistently pessimistic about Chinese growth all year. Some believe that our own Weekly Leading Index contradicts our U.S. recession call. This is not the first time that charge has been made. Recall that, a couple of years ago, people said that its movements guaranteed a double-dip recession. At the time we flatly and correctly rejected that interpretation. Today we can tell you that the Weekly Leading Index is not pointing to recovery and, more importantly, this is also the message from our full array of leading indexes.
For the U.S., the economy is recessionary despite all of the extraordinary efforts by the Fed over the past four years. In that sense, one might argue that, as far as the economy is concerned, the Fed's actions have become increasingly ineffective. The plunge in the velocity of money to record lows tells us that the Fed is pushing on a string - so no matter what they do there will only be limited traction. Basically, the recession has to run its course.
One of the key points emphasized by Achuthan is that recessions are never identified in real-time as they begin. As he notes, the last recession began in late 2007, but GDP data releases were still indicating growth through the first half of 2008. If we have entered a new recession, the revised data will likely not confirm that fact until early 2013 at the soonest. Therefore, it will be important to continue monitoring economic data and market behavior for meaningful signs of deterioration during the next several months.
We will identify the key developments as they occur in our daily market forecasts and signal notifications available to subscribers.