No Recession Yet...
Is the US economy already in a recession? That’s what Lakshman Achuthan of the Economic Cycle Research Institute believes. He made the media rounds last week and his message was a simple one – the US economy has been in recession since July of this year. ECRI has a flawless record of predicting US recessions and so we should probably pay some attention to what Mr. Achuthan has to say, but there is one problem with his call. He’s been making it for over a year now. He first started predicting a recession in the fall of 2011 and said it was unavoidable. If he turns out to be right and we entered recession in July then being off by 6 or 9 months isn’t a big deal and we’ll congratulate ECRI for getting it right again. But for now, the jury is still out.
Predicting turning points in the economy is notoriously difficult. Economic statistics that look good at release time get revised and the recession is usually only obvious in retrospect. There are some data series that give you some real time information but even with those, noisy events can send out false signals. Just to take one example, jobless claims are highly correlated with both economic activity and the stock market. Since the late 70s, if claims are in a rising trend and exceed 400k, a recession and stock market correction are almost assured. During that time, there were several false signals but rising claims are generally a bad sign for growth and the stock market. One false signal came in late 2005 with Hurricane Katrina and that is relevant today since we saw a similar spike from the recent northeast storm. Claims last week fell back to 370k which is roughly where they were before the storm but still higher than we would expect with more robust growth. So, was the spike all about the storm or is the economy weakening? Truth be told, we just don’t know yet.
Another indicator that gets a lot of attention is the ISM manufacturing index and the report last week provided ammo for the recession crowd coming at 49.5 which indicates a contraction in manufacturing. If you look at the indicator over the long term though, its track record leaves a lot to be desired. This survey has been around since the late 1940s and there have been numerous readings below 50 that didn’t correspond with recession. Recessions have also started with the index above 50. We track the ISM but don’t get too worried about it unless it drops below 45 and frankly it is better for calling the end of a recession than the beginning. For now, the ISM manufacturing survey is weak but not recessionary. The slowdown in manufacturing is I believe related to the election and the fiscal cliff. Companies have postponed capital spending projects until they know what the tax code will look like. If – when – that cloud lifts, I suspect manufacturing activity will as well.
Employment is obviously an important indicator and we had another monthly report last week. Unfortunately, looking at these reports in real time is basically a waste of time because they are subject to large revisions. The fact is that there is really no way to track employment accurately on a month to month basis. Last week’s report offered up a dog’s breakfast of conflicting signals with the establishment survey showing a gain of 146k jobs while the household survey showed a drop of 122k. The unemployment rate – at least the official one that gets reported in the news media – fell to 7.7% because the labor force participation rate fell again as the number of people not in the labor force rose by 350k. Again, though, we have to be careful how we interpret this data. The participation rate has been falling throughout the recovery but there are a lot of reasons for that from demographics to lifestyle changes to people just plain giving up looking for a job they’re convinced doesn’t exist. For now, employment appears to still be rising although at a slower pace than anyone would like.
By the way, I saw a disturbing report last week on CNBC from their reporter Phil LeBeau about US manufacturing companies with job openings they can’t fill. The normal explanation for this is that there are no applicants with the necessary skills for the job opening but this report was different. LeBeau profiled two companies with openings that required no skills – apprenticeship type jobs – but had no applicants. Why? It seems that jobless benefits are only slightly less than the starting pay and when you factor in all the other assistance available, taking the job means a pay cut for many applicants. From a short term economic standpoint, it makes perfect sense that these jobs are going unfilled. I don’t know if the answer is for the employers to raise the starting pay or for the government to cut the benefits – maybe a little of both – but having able bodied citizens refusing to take available jobs is a problem on many levels.
The rest of the economic releases last week just confirmed the previous trends. Construction spending rose with activity concentrated in private residential spending, both single and multi-family. Spending is now up almost 10% year over year but it hasn’t translated into jobs yet – construction employment is about the same as a year ago. The ISM non-manufacturing index rose with the business activity index over 60 for the first time since February. Again, though the jobs picture is more bleak with that component barely over 50 (50.3). A report that bucked the trend for manufacturing was the Factory orders report which showed strength, up 0.8%. Auto sales were also higher at a 15.5 million annual rate but as Jeff Snider points out, inventories have been building so this rate probably won’t last. Productivity in the third quarter rose a strong 2.9% while unit labor costs fell by 1.9%. A good indicator for future corporate profits perhaps but another sign that companies just aren’t that interested in hiring.
As for the fiscal cliff everyone is so worried about, it appears we might find out what kind of effect it will have since neither side seems in the mood to compromise. Could going off the cliff be the thing that makes ECRI right again? I have my doubts but if the economy is weaker than it looks – if this data gets revised lower in the future – the tax hikes might be enough to finish the job. I’ve said in recent commentaries that if we get a deal I believe the economy can improve as the trends I’ve discussed previously accelerate. If we don’t get a deal, I still think the trends will assert themselves over time but raising taxes all the way back to pre-Bush levels will certainly delay the process. By the way, I was encouraged to see Apple announce that they will be moving some Mac production back to the US. It is a small investment for them but potentially very significant for the message it sends to other manufacturers.
So, will Achuthan and the ECRI prove correct again? Is the US in recession right now and we just don’t know it? I am skeptical of anyone who believes they have the magic formula for predicting the future course of the economy. The current economic environment is unlike any we’ve ever seen with distortions from both monetary and fiscal policy that are just unprecedented. ECRI’s previously reliable indicators may not be as useful now as they have been in the past. The fact is that no one can see the future and economies are inherently unpredictable. Right now growth is weaker than we’d like but still growth. The dollar is, despite the Fed’s efforts to the contrary, getting relatively and absolutely stronger (versus other currencies and gold). As a precaution, because both of those trends are fragile, our portfolios are positioned conservatively. We would rather miss some of the potential upside if the trends continue – or accelerate – than be caught by a change. In other words, we are doing what an investment adviser should do – acting prudently with our clients assets. We would suggest you do the same until we find out if ECRI is right or if they are just the latest economic soothsayer to discover their own fallibility.