Anirvan Banerji
Six months ago, the leading growth indicators were already starting to roll over, leading me to conclude that further spikes in energy prices could tip the economy into its first recession in a decade. In fact, we had never avoided a recession after the kind of spike in oil-price inflation that already occurred. The possibility that such a downturn would be international, and thus especially problematic, also concerned me.
But because inflation pressures were already headed down, there was room for short rates to drop quickly and head off a recession. Four months later, in January, the Fed started slashing interest rates. But it was too late: It is now virtually impossible for the U.S. economy to avert a recession this year.An Ominous Consensus
That's not merely an opinion, but a factual description of the pattern shown by a wide array of reliable leading indicators that have definitely signaled recession. Think of the various indicators -- leading, coincident and lagging -- as a train that has started to round a bend. If you look at the lagging indicators -- like the train's caboose -- or the coincident indicators -- the coaches in the middle -- you can't tell that the whole train will eventually turn. The trick is to identify the best leading indicators -- the engine -- and summarize them in what we call composite leading indexes. The most timely data are reflected in the Economic Cycle Research Institute's Weekly Leading Index, or WLI, which can historically distinguish between slowdowns and recessions about six months into a slowdown. Because the latest slowdown started in June 2000, the economy was at a fork in the road early this year: If there were a recession ahead, the WLI growth rate would keep going down. If we skirted recession, as we did in 1995, that index would start to recover. Well, after a January bounce, the WLI has kept sliding straight along the recession track. We have now gone past the point of no return. But this is not the only leading economic indicator in ECRI's stable that points to a recession -- so does the Long Leading Index, the Short Leading Index, the Leading Manufacturing Index and the Leading Construction Index. Only the Leading Services Index is ambiguous, and it suggests that a growing service sector just might keep a recession at bay -- though I doubt it. According to the optimists, the labor markets are pretty healthy; so consumer confidence, which drives service-sector growth, will rebound and recession will be avoided. Unfortunately, growth in the ECRI's Leading Employment Index plunged to a 19-year low in February:| Leading and Coincident Employment Indexes, and Growth Rates (in %) |
 |
| Source: Economic Cycle Research Institute |
Is a Market Bottom in Sight?
What does a recession mean for investors? With the major averages in or around bear-market territory, it might be supposed that most of the damage is already done, and many analysts are, in fact, telling us that a bottom is near. But what has driven this market to these depressed levels in recent months are disappointing earnings projections. And as many companies have so euphemistically put it, there is still a "lack of earnings visibility." That means these companies cannot yet see a recovery in earnings ahead. Little wonder, since even our own Long Leading Index, or LLI -- which can usually foresee recoveries even ahead of the stock market -- is still going down. Only after it starts turning up are stock prices likely to follow suit. Let's also remember that virtually all the short postwar recessions lasted eight to 11 months, while the two lengthy recessions each lasted 16 months. The 2001 recession is likely to start in the first quarter of this year or later, since first-quarter GDP
is likely to be positive. If it is, then the recession is likely to end only late this year or early next year. If it is a long recession, it could last through summer 2002. One of the remarkable things about stock prices is that they almost always bottom out four months before the recession ends -- and it turns out the timing does not vary much. What that means is that it's possible that stock prices won't hit bottom until early summer, and they could even keep drifting down until early 2002. And the first indication of any turnaround is likely to be from the LLI. The sizable drops in the major averages, all of which have a significant weighting in technology, are clearly consistent with a recession. But until last month, the New York Stock Exchange composite, which is light on tech stocks, hadn't dropped much at all. In terms of monthly averages, the median decline in the NYSE during a recession is minus 18%. But through February 2001, it had dropped less than 3% from last year's high. Only this month has it declined in earnest, another 6%, making the total drop still a little less than the smallest recessionary declines for the NYSE. Thus there is still downside risk in the nontechnology stocks deemed "safe," which have generally not factored in a recession. If this is a short recession, the further decline is likely to be modest. If it is a long recession, a larger than average decline is likely. Much has been said about a second-half pickup in growth. However, at this time, the leading indices with the longest leads are still heading down, which means that a recovery is not yet in sight. In other words, it is probably too early to be looking for a bottom in stock prices. Let's also remember that this is a global downturn, as I had warned last fall. In such downturns, there is no economy that can act as a locomotive to pull the others out of a slump. As a result, the recession is likely to be longer and more severe. The good news is that inflation pressures are still falling rapidly, with the Future Inflation Gauge declining for the past 10 months. Thus, there is plenty of room for rates to fall further, and that should help mitigate the severity of the contraction.
RSS
