Is the US in a Recession? Update 1-18-08

The article below from Market Watch is a good summary of the how a recession is defined and the current status of the five primary indicators. With that said in my mind the real “show” is not whether we are in a recession, but how the financial intermediaries (commercial banks, investment banks, S&Ls, etc.) are going to weather the current and continuing losses from the mortgage crisis. There are still more problems to come on this issue. If you visit the original article the indicators below are in graphs (just in case you are a graph person).

It's much too soon for an official judgment on whether the U.S. economy has fallen into a recession, but early indications show that a recession may have already begun.

Of the five monthly economic indicators used to judge whether the U.S. economy has fallen into a recession, three are declining and one other is flattening out. Three of the five numbers peaked in September. Only one has grown with any vigor over the past few months, but it's starting to look weaker.

Calling a recession is as much art as science.

The numbers now in hand are preliminary, subject to large revisions. What now seems very weak could be revised to show significant growth. That's why the academics who decide whether we've been in a recession wait a long time before making a judgment.

In some cases, the most recent data are more than two months old, a frustrating delay for those who want to know what's happening right now. What now looks like a peak in activity could turn out to be a local peak or a false top, with the economy regaining strength in the next few months.

"There are a lot of local peaks that don't mean anything," said Chris Varvares, president of Macroeconomic Advisers, an economic forecasting firm.

The evidence currently available is by no means definitive about a recession, but it is not encouraging. There's no easy formula for analyzing the five indicators and only a fool would try to do it in real time.

So here goes:

The street definition of a recession as two consecutive quarters of declining gross domestic product is not quite right. Most recessions have met that definition, but the economic historians who have the task of making these judgments have a more nuanced view that takes monthly data into account.

According to the business cycle dating committee of the National Bureau of Economic Research, "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." Note that none of the housing indicators are part of the analysis.

Payrolls and income

The NBER's single most important monthly number for determining a recession is also the most important for the market: nonfarm payrolls, which are barely growing.

Payrolls have increased for 52 consecutive months, but hiring has slowed sharply over the past year. Payrolls rose just 18,000 in December and have risen at an annual rate of 0.9% in the past three months. Job growth that slow has typically been a recession-warning sign.

As weak as they are, the payroll numbers have likely been overstated. In two weeks, the government will release its annual benchmark revision to 2007 payrolls. Based on a preliminary estimate, the revision is likely to show payrolls were overstated by about 25,000 per month. If the preliminary estimate of the benchmark is right, December's gains could be revised completely away.

Other labor market indicators have also been weak, although they are not officially part of the NBER's tool kit. Employment measured by the household survey is up just 262,000 in the past year, or 22,000 per month.

Conclusion: Payrolls are flattening out.

Income growth

The second most important monthly indicator is real income growth excluding transfer payments. Real incomes peaked in September and have risen at an annual rate of 0.1% over the three months ending in November. The figures are adjusted for inflation. Incomes are closely related to job and wage growth, but also reflect income from small businesses, rental properties, savings and investment.

Real incomes represent the current resources available to consumers. Consumer spending can also be supported by rising wealth. Although net worth is not an official recessionary indicator, the declines in home prices and stock prices in the past few months are probably reducing household wealth for the first time since 2002.

Conclusion: Incomes and wealth are falling.

Output

The manufacturing sector is highly cyclical, often leading the nation into recession. Consumers and businesses buy fewer durable goods when times are bad, but purchases rebound when the first signs of recovery appear.

Industrial production is the broadest measurement of the health of the factory sector. Industrial output was flat in December after peaking in July and in September. Output fell at an annual rate of 0.9% in the fourth quarter, despite strong export growth.

Conclusion: Industrial production is falling.

Sales

Real business sales have been healthy, but are showing early signs of slipping. Unfortunately, the data on inflation-adjusted sales are published with a long lag; the most current data are for October. Sales rose at an annual rate of 4.7% in the three months ending in October.

The most recent sales data aren't comforting. Retail sales fell 0.4% in December in nominal terms before adjusting for the 0.3% rise in consumer prices. Nominal sales for wholesalers and manufacturers were very strong in November, before accounting for the 3.2% rise in wholesale inflation.

Conclusion: Real business sales have been growing, but the data are old.

GDP

The government publishes its GDP figures on a quarterly basis only. The first estimate for the fourth quarter will be released on Jan. 30. Economists are forecasting annualized growth of about 1%.

A top economics firm, Macroeconomics Advisers, publishes a monthly GDP figure that the NBER uses as its fifth monthly indicator. The Macroeconomics Economics GDP is extremely volatile month-to-month. It rose in November, but didn't regain the peak set in September. December's data are not yet available. Varvares, the president of the firm, says the monthly GDP figures are consistent with his firm's forecast for 1.3% annualized growth in the quarterly GDP.

Conclusion: Inconclusive.

Not a pretty picture. But economic downturns never are.