The "Recessionistas" Fight Back
The credit crisis and stock market roller coaster ride over the last year and a half have introduced many new acronyms many have never heard of before (CDOs, CDS, CLOs, etc.) and brought out the wit of the financial industry. Both the bull and bear camps have been slugging it out as they defend their positions while coming up with fond names for each other. For example, the bulls have often used the term penned by speechwriter William Safire, “nattering nabobs of negativity” (NNN), while the bears (Barry Ritholtz) have countered with their own quip, “pervasive pollyannas of prosperity” (PPP).
One of the topics that have been center-stage this year is whether we are in a recession. Those beholden to the recession camp have been labeled “recessionistas,” a term coined by Larry Kudlow who is also a member of the PPP team. Members of the PPP team cited data from the non-manufacturing ISM composite index which rebounded in April above 50, indicating an expansion (Contra the Recessionistas), though it fell back below 50 in June. With the recent Q2 GDP report, the “recessionistas” have further support to their position as real GDP rose at an annualized rate of 1.89%, below the consensus expectations of 2.4% growth.
However, no GDP report should ever be read without looking at the implicit price deflator which is subtracted from nominal GDP to produce the inflation-adjusted real GDP figure. What was underreported on the day of the GDP release (though surprisingly not missed by Mr. Kudlow) was that the GDP deflator fell from an annualized rate of 2.56% seen in the first quarter to 1.11%, which is utter nonsense as oil prices rose to nearly $150 a barrel and the headline CPI continued to advance. Since the fourth quarter of 2007 there has been a major discrepancy between the GDP deflator and other measures of inflation as seen below.
The spread between the GDP deflator and the headline CPI figure is rising considerably as the two are trending in opposite directions, currently at 2.4%. The last time the spread was this large was the year The Empire Strikes Back came out in 1980! As has been pointed out in the past, the spread conveniently widens during recessions to keep real GDP higher than what it would be using headline CPI numbers as shown below.
A breakdown of the GDP deflator is seen on page 4 in Table 1.1.8 in the GDP report (click for link to report), which shows the contribution to the percent change in the GDP price index. The breakdown for the second quarter GDP deflator is shown below.
- Personal consumption expenditures (PCE): 2.93%
- Gross private domestic investment: 0.09%
- Net exports of goods and services: -3.30%
- Government consumption expenditures and gross investment: 1.34%
- Net change: 1.1%
The GDP deflator should be aligned more closely to the PCE deflator due to its sizable weight of 71.2% of GDP, and as shown in figure 5, using the PCE deflator shows we have been in a recession since the fourth quarter of last year.
The official definition of a recession is two consecutive quarters of negative annualized growth. So far we have seen only one negative quarter of real GDP growth, which was the -0.172% rate seen in the fourth quarter of last year. However, and to the chagrin of the PPP team, using a more realistic inflation measure to deflate nominal GDP shows an official recession with an additional quarter to boot. Using either the headline CPI figure or the personal consumption expenditure (PCE) deflator shows three consecutive quarters of negative annualized growth -- yes an official recession.
What’s more, real final sales to domestic purchasers (RFSDP) has accelerated its decline and is approaching a negative year-over-year (YOY) rate of change, an event seen only six times in the last half century. Another nail in the coffin is that RFSDP has fallen below the critical 2% level. Over the past 60 years we have entered into a recession any time the rate falls below the 2% level, NO EXCEPTION. In fact, the 2% level not only marks the start of a recession but also its end as the economy often remains in recession until RFSDP rises above the 2% mark as seen below.
The inflation-biased strength seen in the second quarter GDP number is likely to be a one-time event as the effects of the stimulus checks wear off and the reality of the true state of the economy sets in. The Economic Cycle Research Institute’s (ECRI) Weekly Leading Index (WLI) has had an excellent track record in predicting the path of GDP growth with a lead time of nine months. The current plunge in the five month moving average of the WLI is heralding rough times ahead as it hasn’t been this negative since the severe recession of 1974. Not only does a drop off in the WLI index mean hard times ahead for the economy, but so too the stock market as the rate of change in the S&P 500 has a strong correlation with the WLI, which shows no sign of a turnaround.
Source: ECRI/ Standard & Poor’s
Further support of economic weakness ahead is seen from the labor market, with non-farm payroll growth dipping into negative territory in July with a -0.049% growth rate, the first negative reading since July of 2001, right in the middle of the last recession. Like the 2% growth demarcation for RFSDP, over the last sixty years we have been in a recession every time the employment growth rate falls into negative territory, NO EXCEPTION.
As employment growth slows, the unemployment rate has risen and is likely to rise even further as evidenced by the Conference Board’s jobs hard to get index, which has accelerated markedly this year. The growth rate in the jobs hard to get index leads the unemployment rate by one year, indicating the unemployment rate is likely to rise well into 2009.
Source: BLS/The Conference Board
Further evidence of widespread weakness in the labor markets is the burgeoning population of part-time workers for various reasons. Those working part-time due to slack business conditions have reached a record level while those working part-time due to economic reasons have surpassed the 2001 high and are approaching the levels seen in the 1981 and 1991 recessions. Even when measured as a percent of total employment, those working part-time for economic reasons or those that could only find part-time work have reached levels above the 2001 recession and are rising fast.
Clearly the PPP team is up against the wall as one negative economic indicator after another continues to deteriorate and the effects of the stimulus checks wear off. A housing bottom remains elusive and the credit markets remain in turmoil as the tally of failed banks continues to rise with two more seen in July (FDIC Press Release). Save a Marshall Plan to stimulate the economy coming from the government in the near term; it looks like the “recessionistas” have the upper hand.
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