Put Some Perspective on the Economy By Brian Reynolds Special to TheStreet.com 8/7/01 4:08 PM ET

It's been an even crazier year for investors than for Boston Red Sox fans. Both the economy and the Beantown 9 have faced some unique challenges this year, yet both have shown resilience. Unlike baseball, though, the investment process has no season-ending grand finale. To stay in the game, I've found that putting some perspective on the economy's ups and downs can help me make better investment decisions.

With nearly a year gone since industrial production peaked, now might be a good time to compare this economic slowdown with past recessions. (While this economic environment may not meet the technical definition of a recession, it sure feels like one.) In the charts below, I'll look at how some of the major components of the economy have fared since last September and contrast that with the past five recessions.

The Bad Old Days A look back at the past five periods of recession
Recession Start Date	Duration in Months
December 1969	11
November 1973	16
January 1980	6
July 1981	16
July 1990	8
Source: National Bureau of Economic Research

First, we'll take a look at overall gross domestic product growth for the current cycle and for past downturns. While all downturns are painful, each has its own unique characteristics.

Real GDP Percent change from economic peak

Source: St. Louis Federal Reserve Bank

Overall economic activity, as measured by GDP growth, has been stronger in this cycle than in any other downturn. This performance could be considered remarkable, given the challenges the economy has faced: the tripling of oil prices from 1999 through last year, the collapse of the dot-coms and telcos and the horrendous slide in the stock prices of such widely owned names as Cisco (CSCO:Nasdaq - news - commentary) and Lucent (LU:NYSE - news - commentary).

The big question is where the economy is headed from here. I know many bond investors who look at the economy's resilience combined with the aggressive Fed easing this year and fear the economy will come roaring back. I know other investors who look at the excesses that built up at the end of the past decade and feel that the economy is only beginning a long slide.

What has really kept the economy going is personal spending, which accounts for about two-thirds of economic activity. I think the course of spending will determine whether the economy falls into a traditional, full-blown recession.

Real Personal Consumption Percent change from economic peak

Source: St. Louis Federal Reserve Bank

So far, consumption has turned in the second-best performance of the downturns highlighted. Only the 1969 recession, which was virtually over at this point in the cycle, turned in a stronger performance.

The real weakness in the economy has been on the manufacturing side.

Industrial Production Percent change from economic peak

Source: St. Louis Federal Reserve Bank

Industrial production's performance during this cycle has been weaker than that of any except the 1981 recession. The current decline has been more relentless than any of these; the other cycles had at least one up month.

In contrast to the horrible production numbers, employment has held up relatively well.

Payroll Employment Percent change from economic peak

Source: St. Louis Federal Reserve Bank

Payrolls have dipped during the past few months, but not nearly as severely as they typically do during a downturn. That may be because, until this year, the hardest task that many companies faced was finding and retaining qualified employees. Unemployment is still relatively low, so companies seem to be reluctant to part with their workers unless absolutely necessary.

In the short run, cutting production more than payrolls can be disastrous for profitability and productivity. But the relatively low level of job declines has also allowed incomes to continue rising and has supported personal consumption.

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A few months ago, I wrote that I didn't see consumption accelerating greatly (other than for a brief spike due to tax refunds) nor falling sharply. These data strengthen my view. If the economy does start to rebound, hiring probably won't be very strong, given how little payrolls have been cut during this slowdown. That means incomes won't rise very quickly at the start of the recovery and that profitability could rebound faster than the economy. If the economy worsens and payrolls are trimmed more, I think that long-term bond yields will fall and the resulting increase in refinancings will help to support the consumer.

The best news in this cycle relative to others has been on inflation. In the past 30 years, recessions have tended to coincide with surges in inflation, usually caused by a jump in oil prices. The tripling of crude-oil prices from early 1999 through the end of last year had the potential to produce a large ramp-up in inflation, yet the performance of the consumer price index during this slowdown has been lowest of these cycles.

Consumer Price Index Percent change from economic peak

Source: St. Louis Federal Reserve Bank

The current economy has performed both better and worse than it typically does in a downturn. As I've said before, I think we're in a 1991-type of environment, where the overall economy doesn't accelerate sharply or drop precipitously.

If that's true and if energy prices have really topped out, then inflation can work its way lower and provide support for stock and bond prices. These data, along with the relationship of the economy to the markets that I examined last week, make me more comfortable owning more stocks and bonds than I did at the beginning of the year. You might reach a different conclusion about the economy and will thus want to have a different asset mix than I do. Nevertheless, you can use this information to get some perspective, and that's an integral part of the investing process.

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