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Market Bullheaded on Recession Call

Equities ironically rise and bond prices decline on the news but one economist warns of a 'false dawn.'
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SAN FRANCISCO -- A little more than a year ago, (presumptive) Vice President-elect Dick Cheney and Morgan Stanley Dean Witter economists Stephen Roach and Richard Berner put themselves at the forefront of a debate over whether or not the U.S. economy was headed for recession.

Then last March, the Economic Cycle Research Institute declared a recession to be

unavoidable. As the months went by and the economy kept sputtering, more and more economists began to come around to that view, particularly after Sept. 11

Today, the National Bureau of Economic Research (NBER)

declared that the U.S. economy ended its 10-year expansion and fell into a recession in March.

Although gross domestic production expanded by 1.3% in the first quarter and by 0.3% in the second, the bureau "gives relatively little weight to real GDP" because it is reported quarterly and subject to "continuing, large revisions." Instead, NBER focuses on employment and personal income, as well as manufacturing and industrial production to derive what is the nation's "official" declaration of when economic cycles begin and end.

Rather than the common definition of recession as two consecutive quarters of declining economic output, the NBER attempts to identify what month the economy peaked and what month it troughs; "The time in between is a recession, a period when the economy is contracting," the bureau said.

The financial markets' reaction to the NBER's announcement was curious.

Bonds, which fare better in periods of economic weakness, nevertheless continued their recent tailspin. The price of the benchmark 10-year Treasury fell 9/32, its yield rising to 5.02%.

Stocks, on the other hand, fare worse in periods of economic distress and have been rallying sharply since late September, and thus had ample excuse to retreat today. Yet, the

Dow Jones Industrial Average

rose 0.2%, the

S&P 500

gained 0.6%, and the

Nasdaq Composite

climbed 2% to its highest close since Aug. 14.

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The stock market's advance -- however muted -- can be explained in two parts.

First, many traders believe the bond market's recent failings -- meaning higher yields -- are a harbinger of an economic rebound, and thus bullish for stocks.

"Many are citing the recent performance of the stock and bond markets as evidence of imminent recovery; we continue to see the rally as an oversold bounce," countered Thomas McManus, equity portfolio strategist at Banc of America Securities.

Ironically, the bond market's rally in late October was espoused to be bullish for stocks as well, because the (then) lower yields presumably made stocks more attractive on a

valuation basis.

Hmm, maybe this really is a new bull market because only in a bull market can both rising and falling bond yields be declared "good" for stocks.

A second, more immediate factor in the stock market's rise today is that many investors believe the NBER's declaration of recession "might guarantee the downturn has possibly run its course," as McManus observed.

Given that the NBER said that "most recessions are brief,"

optimistic observers could be forgiven for believing the slowdown can't last much longer. Optimistic comments by Treasury Secretary Paul O'Neill, who called the NBER's recession announcement "a measure of the past," further fueled such sentiments.

One major problem with this theory is that the pundits who forecast the recession ahead of the pack aren't so sure it ends anytime soon.

"I continue to worry about a U.S. economy that hits another air pocket in the early months of 2002," Stephen Roach, global economist at Morgan Stanley, wrote today. "For financial markets rallying on the premise of postshock healing and recovery, any such air pocket could come as an especially rude awakening."

Roach also warned that another downturn in the U.S. economy "could also trigger another wave of deterioration in the global trade cycle -- the stuff of an ever-deeper synchronous recession."

Lakshman Achuthan, managing director of the Economic Cycle Research Institute, expressed similar concerns in an exchange today with's

deputy managing editor Charlotte-Anne Lucas, who graciously passed them along to me.

On Thursday (while we were eating), Germany announced its GDP has been contracting for the last two quarters, Achuthan noted. "So we have the U.S. in a recession, we know Japan is in recession and we now know Germany is as well."

It's been a quarter century since those three major economies were in a recession simultaneously, he continued, recalling growth in Japan and Europe "made our recovery easier" in the 1990-91 recession.

The NBER's announcement that the recession began in March demonstrates that the Sept. 11 attacks didn't cause the contraction, he continued. "Before the attacks, we were comfortable with the idea that we could get away with a mild recession. The attacks made that less likely."

While the equities market "seems to be saying the recession will end sooner, rather than later," Achuthan is looking for some "noninvestor-related indicators to rise" before he's convinced, including a steep drop in jobless claims or big rise in new orders.

Barring that, "we run the risk of a sort of false dawn, not unlike

in the second quarter," he added. "There's something in the reality that's being overlooked and rationalized away by the equity markets."

Hmm, the equity markets, "rationalizing away" reality? Sounds like a bull market.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.