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Recession Check: Updating The Indicators
Submnitted by Lance Roberts via STA Wealth Management,
In December of 2007, I wrote in my weekly newsletter that we were "...either in, or about to be in, the worst recession since the 'Great Depression.'"
At that time, the warning rang hollow as GDP growth was positive, and the markets were still marching higher as the calendar turned to 2008. It was a year later, in December of 2008, that the National Bureau of Economic Research (NBER), stated that the recession did, in fact, begin in December of 2007.
So, here is the question. What economic evidence was available in late 2007 that suggested the U.S. economy was on the brink of recession? Here is a partial list.
- Real PCE below 2% annual growth
- LEI annual change below 0% growth
- Annual growth rate of S&P 500 operating earnings is negative
- Annual growth rate of S&P 500 after tax profits is negative
- 4-week moving average of jobless claims beginning to rise
- 3-month average of the annual growth rate in retail sales below 3%
- Consumer confidence on the decline
With the US economy now more than six years into the economic recovery, the question simply becomes how close are we to the end of the current business cycle. This is critically important to investors since the bulk of capital destruction, due to major market reversions, have historically occurred coincident with the onset of recessions.
Let's take a look at the same list of indicators that correctly pinpointed the beginning of the last recession to gauge where we reside in the current business cycle.
Real Personal Consumption Expenditures (PCE) (YoY % Change)
Personal consumption expenditures comprise roughly 70% of the GDP calculation and, therefore, is an important consideration in determining the overall strength and status of the current economy. Historically, when the annual growth rate of PCE has fallen below 2%, it has warned of a substantially weak economic environment and acted as a precursor to the onset of a recession.
Currently, at 2.7%, PCE is above that warning level and the upward slope of the trend suggests that no recession is currently imminent. However, there are two things of importance to note:
- The data which comprises PCE is subject to large backward revisions, and;
- The change in trend can occur very quickly.
It will be important to monitor PCE closely in the months ahead as the economy continues to operate at extremely weak levels.
Leading Economic Indicators (LEI) (YoY % Change)
In July of 2014, I modeled a projection of the LEI going through 2016 assuming a continued growth rate in the monthly index. As shown, EVEN if the LEI continues to churn out positive growth in the months ahead, the index will continue a decline due to the issues of year-over-year comparisons.
Historically, growth rates below 0% are have provided a leading indication of the onset of a recession. However, it is worth noting the there tends to be a long lead in the decline of the LEI before the 0% level is breached. That decline is currently underway and can occur very quickly.
S&P 500 Operating Earnings (YoY % Change)
Operating earnings of S&P 500 companies have previously been negative for at least two consecutive quarters by the time a recession begin. Currently, through last completed quarter of 2014, operating earnings were negative. If Q1 also prints a negative, this will be first back to back decline in operating earnings growth since 2012 when the Japanese tsunami crushed manufacturing.
The only reason the economy likely did not print a recession in 2012 was due to massive ongoing Central Bank interventions and the warmest winter recorded in 65 years. As Japan recovered following that devastation, the pent up demand for manufactured goods gave a boost to economic growth and production when normally it likely would not have occurred. That is a series of events that is unlikely to repeat currently.
S&P 500 After Tax Profits (YoY % Change)
Likewise, real net after-tax profit margins have also been under attack for the last several quarters. Historically, several consecutive quarters of negative growth in after-tax profits have provided warning of a substantially weaker economic environment.
Jobless Claims (4-Week Moving Average)
As I discussed last week, jobless claims are currently at their lowest level in 42-years as companies have come to the end of workforce reductions to boost profitability. As shown in the chart below, such low levels of jobless claims tend to denote the peak in economic growth. It is the reversal of that trend of jobless claims that has provided the recessionary warning signs. Watch for a turn higher in the 4-week average of jobless claims in the months ahead.
Real Retail Sales (3-month Average of the Annual % Change)
The annual percentage change in real, inflation-adjusted, retail sales has also been a good indication of what is happening in the economy. Retail sales make up about 40% of PCE, so it is worth watching the monthly report as an indication of what is likely to show up in the quarterly PCE report.
Currently, not only are real retail sales below 3%, but also the 2% recession warning line. This suggests that the consumer is much weaker than most currently suspect. If this weakness is not reversed soon, it will likely begin to pollute a majority of the other indicators that are not yet warning of an immediate recession.
Consumer Confidence
Confidence is a lagging indicator at best as it is a reflection of how consumers "feel" at the time of the poll. It also has to do much with "how" the poll questions are phrased to extract a specific type of response.
The chart below is a composite of the Census Bureau and the University of Michigan consumer confidence surveys. It is worth noting that consumer confidence tends to peak and then fall very rapidly just prior to the onset of a recession. This is primarily due to the realization that what was expected to occur has failed to materialize. Other than during the "dot.com" bubble, confidence has tended to peak at 100 on the index.
The decline in retail sales, as noted above, is leading consumer confidence index as it reflects what consumers are actually "doing" versus how the currently "feel."
No Recession Yet...
The largest problem with the data sets above is that they are all subject to large historical revisions. This is why the NBER is ALWAYS well after the fact in pronouncing the start and end of recessions in the U.S. economy. Given the ongoing interventions from the Federal Reserve and the current administration, it is likely that many of the statistics, and seasonal adjustment metrics, have been skewed in recent years. In the quarters ahead it is likely that we could see rather sharp adjustments to historical data which may suggest the economy has been far weaker than headline statistics have suggested.
The suppression of interest rates and inflation of asset prices have, in particular, elevated the LEI far above levels that it would be reporting otherwise which has also boosted much of the economic outlook.
For investors, it is the trend of the data that is far more important that the single data points themselves. While the majority of indicators that correctly predicted the recession in 2007 are currently not suggesting an imminent recession in the U.S. economy, it does not mean that a recession can not begin to form very quickly.
Risk is a function of "loss," and being caught on the wrong side of an economic recession can be very detrimental to long-term portfolio returns. So, just because the data currently suggests that portfolios remain more tilted toward equity exposure, it should be done so with a healthy dose of caution.
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Blow it up already. My shit has a limited shelf life.
Another trolling Mr List-of-signs-and-signals.
Unless you've got something better, don't knock it. Our problem is the FED and Wall St. are bending things up. Watch the commodity and bond markets though since they are starting to get pretty nervous and tend to be the panic signal in our present passion play. I'm still betting on late summer, early fall for things to get bad enough that they can't paper over the cracks anymore.....
We're seeing the cracks already. I don't like to forecast but my bet Sept/Oct timeframe SHTF!
WE'RE seeing cracks, Wall St. can't see a frigging thing through their rose colored welding glasses......
Don't fight the tape. Market will slip when it decides to "see" these data.
I don't think there will be a "decide to see", it'll likely be shoved forcefully into their collective anal orifice......
I think people are discounting the Fed's desire to normalize rates more than they should. They know they've let this go too far. The stock market is too hot and now the housing market just popped. Art is too bubbly. The Fed can't be expected to offset dysfunctional fiscal policy with monetary policy without dysfunctional results.
....due to central bank interventions.
Another way of looking at it . . .
http://research.stlouisfed.org/fred2/graph/?g=1bQy
There's nothing wrong with the economy, Zero Hedge morons.
In other words, gold will continue to crater and equities - you know, those things you sold years ago so you could protect yourself from the impending stock market crash - will continue to climb high into the sky.
No, it's not quite a 'permanently high plateau', but it's pretty close.
So continue to sulk and commiserate amongst your fellow dumb-money chumps. There is certainly no shortage of wounds to lick, so get busy!
While I agree with the point of your comment, it would seem that prospective long-term annualized equity returns from here will be slim. For example . . .
http://research.stlouisfed.org/fred2/graph/?g=1bQB
And now we all know thefourthstoog-ing is an idiot.
Just in case you didn't know, this is not our beloved Shemp. This one is "stoog", not "stooge". FYI
Yep, I think of this one as the stooge-ning.
(I don't know if that translates outside of Godzone)
That went straight over my head. Can you expound? I'm kinda stupid, in some ways.
Be careful, I can be the web's biggest asshole, too.
Yes,
and the infrastructure in the US is absolutely PRISTINE. And the manufacturing base is stronger than ever....
My forth stool? What are you doing here? I thought I just flushed you
Dude, 1,200 + job applications in a year and no job. Yeah, fuck charts. Don't need em. This is indication enough for me. Thanks!
Phew!
I thought for a minute there with the housing starts that the economy is actually improving. Now that I see it's really not I think it's safe to BTFATH cause we are going precipitously higher bitchez!
subject to large backward revisions
Really? That is very surprising...
(end sarc)
Christmas 1015 should be fun.
Having a boatload of Vikings over ?
Well just like in 1880s when the banks removed Silver Certificates from use by the farmers... money gets tight and debt rises too high as the debt burden from Usury from the Private Banks... screws everyone.
Bubble Created for the Banks Greed.
Bubble Kept for the Banks Control/Greed.
Bubble called Sacred for the Banks Control/Greed.
Bubble must be protected for the Banks Control/Greed.
Bubble adorned with LIRP/ZIRP for the Banks Control/Greed.
Bubble Socialized with QE of $4 Trillion for the banks Control/Greed.
Credit to GDP Chart shows we are still in Credit Bubble Territory and how obvious it was in 2003 (over 50%).
Bank Private Credit to GDP for United States
2011: 55.47615 Percent (Data spans from 1961 to 2011)
http://research.stlouisfed.org/fred2/series/DDDI01USA156NWDB
But this one looks worse (Delinked to Deposits? Bubble 1996, 1998, 1999):
Private Credit by Deposit Money Banks and Other Financial Institutions to GDP for United States, 2011: 189.51640 Percent,
http://research.stlouisfed.org/fred2/series/DDDI12USA156NWDB
As long as Congress also got a chance to get Rich it is OKAY.
we don't have Honest Brokers in a single US Agency DOJ, FBI, SEC, FINRA, FTC, GAO, CBO, FED, Treasury, OCC, FSOC, BCFP, CFTC, FDIC, FHFA, SIPC, FEC.
Hm... Jeb Bush signed PNAC Letter as a Principal:
Elliott Abrams[3]
Gary Bauer[3]
William J. Bennett[3]
John Ellis "Jeb" Bush[3]
Dick Cheney[3]
Eliot A. Cohen[3]
Midge Decter[3]
Paula Dobriansky[3]
Steve Forbes[3]
Aaron Friedberg[3]
Francis Fukuyama[3]
Frank Gaffney[3]
Fred C. Ikle[3]
Donald Kagan[3]
Zalmay Khalilzad[3]
I. Lewis "Scooter" Libby[3]
Norman Podhoretz[3]
J. Danforth Quayle[3]
Peter W. Rodman[3]
Stephen P. Rosen[3]
Henry S. Rowen[3]
Donald Rumsfeld[3]
Vin Weber[3]
George Weigel[3]
Paul Wolfowitz[3]
The Las Vegas gaming "win amount" as reported by the UNLV Center for Gaming Research (fun job!) has been a good recession indicator as far back as the numbers go, Y2K. According to this indicator, we're in a recesion now and have been since sometime last year. Seehttp://gaming.unlv.edu/reports/longterm_nvgaming.pdf and http://gaming.unlv.edu/reports/6_month_NV.pdf
My favorite part of the charts is the boner spike in Q2 2009.
Like the business cycle can really post a 250% increase in three months during the deepest part of the recession. Golly, what changed in March of 2009? Oh yeah, Mark to Market was abandoned and Mark to Fantasy was officially recognized as accepted accounting. What was hundreds of million in losses instantly became hundreds of million in profit without any change in overall sales. Amazingly massive amounts of inventory that was being held off the books for accounting purposes appeared making it look like industrial production had exploded. In reality the product was gathering dust and had always been there. But thanks to a simple accounting change every company rushed to put the inventory on the books to count as assets to borrow against. What would have sunk you a year before was now your path to massive new lines of credit.
You can't base anything on the "recovery" because the recovery only exists as a figment of an accountant's imagination.
EETS AWL BOOLSHEET, FOOKIN BOOLSHEET!!!!
+1. nice catch on the accounting standards revisions.
edit: holy shit! I overlooked that. that 'boner spike' is amazing! draws the integrity of the metric into question, and what you've said is the only way I can think to make sense of it.