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Five of Six Recovery Indicators Retreat; Two Fall Below December 2007 Recession Levels

By on February 6th, 2014

There has been a major change in the recovery indicators. Two of the six indicators are below levels at the start of the recession in December 2007, and five of the six retreated from the last report. (click to enlarge)

recovery 020514

The NASDAQ had a rough month along with the rest of the stock market. Concerns about emerging markets and their monetary situations sent stocks lower. Many exchange-traded companies reported higher earnings but indicated stagnant sales levels; some proffered weak future sales or earnings guidance, giving another reason for the plunge. Of course, there’s always Apple, an important part of the NASDAQ, which was punished because they only sold 33,000 more iPhones per day than last quarter. Some people are just not satisfied, it seems. It could be that stocks are just “tired” for now; they had a good run last year.

The big concern is that the ISM manufacturing new orders index got slammed, down more than 20% and imports down almost 3%. Both are still over 50 (51.2 and 53.5, respectively) indicating slow growth. The magnitude of the decline is the shocker, and is something we hinted at as possible in our (“laughable and embarrassing“) blogpost last week. There we said it was the increase in inventories that made real GDP seem good when it was not. Economic and regulatory conditions provided a foundation for a combination of management actions in Q3 & Q4-2013. These took advantage of the period before the weekly hours of work restrictions of the ACA. This meant that Q3 and Q4 were the last months of wide flexibility in labor scheduling. Implementation of the ACA also meant that benefits costs of those workers would be significantly higher starting in 2014. The final factor was the belief that interest rates would rise in 2014 as the Fed started to taper its quantitative easing efforts. The savings in total labor costs, and the lower holding costs of extra inventory created by that labor would be low in Q3 and Q4 compared to 2014, hence the incentive to build inventories of goods because of their expected lower per unit costs. The costs of that inventory were lower than the costs of future units of production. Going into 2014 with higher inventory levels would create a buffer for cutbacks in hours and headcounts in 2014.

The ISM manufacturing new orders index might be an affirmation of that line of thinking. Its -20% decline was the steepest since October 2008, just before the announcement that we had been in recession for 11 months. Unlike that October 2008 report, which dropped the index down to 33, the current new orders index remains slightly above 50, indicating slow positive growth.

On the non-manufacturing side, the new orders index increased from the last report, but is still below the level of December 2007. The imports index also decreased below the levels of the recession’s start.

Proprietors income, mentioned in last week’s post, contracted by -0.6%. This was the first decrease in this data series in four years, in Q1-2010. This is the only measure in the GDP and personal income reports that provides some insight into the state of small business. I’ve often mentioned the National Federation of Independent Business (NFIB) Small Business Index. That data series remains mired between two recession bottoms: that of the early 1990s recession and that of the early 2000s. This is the latest chart; new data are released next week. (click chart to enlarge)

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If this turns out to be the first indications of a new recession, the arbiter of such designations, the National Bureau of Economic Research (NBER) will have a tough time figuring that out. It is common to believe that a recession is two quarters of negative growth, but that is not the official definition. Technically, you don’t need negative GDP to be in a recession, but you do need a range of economic measures to be in serious trouble. Negative GDP, however, is something easy to understand. Right now, negative GDP seems unlikely. The indicators may just be signaling a much slower growth rate, probably in the 1.0% to 1.5% range. As for a recession, low growth rates always mean that you are closer to the precipice than usual, and the likelihood of falling is always higher when you are close to the edge.

But would we detect a new recession in a timely way? The recession that started December 2007 was not declared until 11 months later. The other problem is that many data series have not reached the levels that they were at when the December 2007 recession began, meaning that they never really recovered. This might finally be the start of the “double dip” that was in almost every economic analysis of about three or four years ago. Whether or not a particular period is declared a recession is meaningless for those who run businesses. The NBER had trouble detecting the recovery. Their declaration that the recession ended in June 2009 was made fifteen months later in September 2010. If it turns out a new recession began, NBER’s pronouncement will be late and very nuanced, and not useful for making business decisions. Yes, these economic times are that strange.

Businesses run in real time and make decisions based on the conditions they are experiencing. Recessions are always declared in hindsight, mainly by academic economists who do not have to deal in a direct with decisions about allocating time, capital, or workforces in the pursuit of customers. Academic economists can only make business conditions assessments based on published data, and the data they need are not in real time. They have to wait for data to be refined and for those data to show a pattern first.

Real-time decision makers can’t wait, and need to take actions using experience and what they directly observe, which is not always quantitative. Keep your eyes open and be observant. Be curious and ask questions. Remember, any economic downturn will increase the intensity of the shift to digital media. That means hunkering down and waiting for difficulties to pass is not a choice. If your company has not accommodated current and future media shifts in some strategic manner, it might be getting too late to do so.

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  1. 9 Responses to “Five of Six Recovery Indicators Retreat; Two Fall Below December 2007 Recession Levels”

  2. By Patrick Henry on Feb 6, 2014 | Reply

    Thanks, Dr. Joe, for a must-read (and a must re-read). I’m not happy to know how fragile this so-called recovery actually is, but I’m grateful for the hard dose of reality you’ve given us in this sobering essay.

  3. By Eric Taub on Feb 6, 2014 | Reply

    Just to confirm – you are calling a recession starting now that will be realized a year from now?

  4. By Dr. Joe Webb on Feb 6, 2014 | Reply

    I don’t call recessions. The NBER does. This is the likely scenario as mentioned above: “The indicators may just be signaling a much slower growth rate, probably in the 1.0% to 1.5% range.” The likelihood of a recession is greater now than it was 90 days ago. I think there’s more of the annoying muddling sideways stuff ahead of us, but it may not meet the NBER criteria.

  5. By Wayne Lynn on Feb 6, 2014 | Reply

    If the non-manufacturing data in your panel of indicators means what I think it does, i.e., retail, services, construction, agriculture, etc. this is a sobering report. The economy is not only teetering on the edge now but, given that non-manufacturing hasn’t exactly blown the doors off for a few years now, the economy is weak fundamentally. Correct me if I’m wrong but this is not a happy thought. The economy may be unable to do anything but muddle sideways.

  6. By Dr. Joe Webb on Feb 6, 2014 | Reply

    The services industries (excluding food and accommodations) tend to be a buffer in the economy against larger swings on the manufacturing side. The recent exception is the bursting of the housing bubble, which hit the construction business very hard. The mild rebound in construction is one of the contributors in the rise in proprietors income. That was a bubble, so the higher you get the more that 32 feet / second / second thing comes into play :) That bubble aside, the services sectors benefit from the productivity investments companies are making, such as outsourcing administration, buying computer services and management, communications services, etc. During this period there have also been many advances in logistics and transportation (excluding the USPS, of course). So don’t get too worried over services; they’ll be slower, but the carnage of 2008 in construction and banking is not likely to repeat. There’s less height to fall from.

  7. By Eric Taub on Feb 6, 2014 | Reply

    Interesting non-consensus view. Given that employment continues to slowly improve, PCE is rising, the Senior Credit Officer survey shows banks looking to lend more aggressively and corporate balance sheets are strong it is surprising that you see a contraction. I see the beginning of a CapEx cycle funded by still cheap interest rates that will lead to more employment and spending.

  8. By David Schwartzbaum on Feb 13, 2014 | Reply

    The warning signs have been there for a very long time. No one wants to say it outright, but the current Administration’s “social agenda” policies are slowly drowning us in debt and malaise. We are basically a mirror image Japan’s catatonic 1990’s economic performance, as the BRIC countries are eating our lunch.

    Let’s face it- Obamacare is a nightmare, and we haven’t even seen the tip of the iceberg yet. There is far too much uncertainty in all markets, and manufacturing in America has all but disappeared. The only surprise, really, is that we have not seen these numbers sooner.

  9. By Dr. Joe Webb on Feb 13, 2014 | Reply

    You have to wait for the pendulum to swing back the other direction, and that may take another 6-10 years. There are differences in the examples you cite that are notable, though. Japan is in a severe demographic decline, which is different than what is happening to the US population. The lack of young people is affecting their ability to work their way out of their future debt obligations. The BRIC countries are already “not what they used to be.” They, too, expanded their money supplies rapidly and are starting to see rising inflation and economic slowdown. China’s “shadow banking system” that created its construction and real estate boom is now of great concern. India looks like it is taking a political swing back to its older policies. Russia has severe negative demographics. So, they are not eating our lunch, but have been significant opportunities for new investment in those countries, especially India and China. Those are the two that will continue to have a rocky road with an upward economic slant. If Brazil avoids looking like Argentina and focuses on investment, it can return to higher growth rates. All of the populations in B, I, C have had rising incomes and rising education rates. R is another matter. US worker productivity is still way ahead of the BRIC countries.

    The ACA is a nightmare, which is why it keeps being postponed. In the process, there is growing awareness of its unintended consequences and negative incentives. But it will stay in place with constant tweaks, making the law more complex and a great opportunity for regulatory mischief. Where there is regulation, there are lobbyists. Fixing the law can become a big gravy train for Congress, catering to special interests on all sides, just like many other regulatory processes. Don’t worry: the ACA will get worse. While there is wide dissatisfaction with it, there is still general interest in solving health care issues with political solutions whether it’s the ACA or other means, no matter the obstacles it might create. It is generally believed that the obstacles are bumps along the way to a greater social good.

    Manufacturing is often mischaracterized in government data. Look at the top three companies in the world by market capitalization: Apple, Google, and ExxonMobil. Apple makes very little. Its value is based on its design and intellectual property (good article from about a decade ago: “We Think, They Sweat“). There are manufacturing businesses that are more automated than before because of computers. Designing such a factory is built using service businesses: architects, legal, finance, electrical engineers, utility services, computer scientists, software developers, etc. The actual manufacturing plant might be the riskiest part of the transaction. Apple shifts the risk of owning manufacturing to others because it knows its strengths are in design, planning, and development. Those are the new long-term assets. Manufacturing is more risky because of displacement by competitive technologies and the actions of competitors than ever before. In the process, when you exclude food and accommodation employment, service jobs pay more than manufacturing jobs. Google, which has revenues in the range of $1.2 million per employee, far in excess of manufacturing businesses (depending on industry by factors of 5x to 10x), is far more lucrative than manufacturing. While ExxonMobil looks like a manufacturing business, much of it is not. Its petroleum processing is manufacturing, but many of its other operations are services, such as its pipeline transportation management. Companies like UPS and FedEx are exceptional organizations, delivering high returns to shareholders, and with highly paid workers (one is union and one is not, which makes for interesting case studies), and are service businesses. They don’t manufacture anything.

    The definition of a manufacturing worker is also a problem. If a manufacturing business has a cafeteria, those workers are classified as manufacturing workers. If they have a payroll department, the clerks are manufacturing workers. If the cafeteria is licensed to Host Marriott, they usually hire the same workers. Overnight, those same people working in the same space go from being manufacturing to service workers. If the payroll department switches to ADP or PayChex, and those companies hire the same clerks, they become service workers overnight. If the manufacturing company decides to get rid of its delivery personnel and has those personnel hired by a trucking company, they become service workers.

    As economies become more complex and knowledge becomes more specialized, service industries thrive from the shift of tasks once considered internal to become external. Workers are classified not by their tasks but on the main category of the company in which they work.

    Uncertainty is an essential part of economics. Without uncertainty, there is no need entrepreneurship, nor is there a any need for management executives. I have always contented that the claims of uncertainty are baseless, and are more a recognition of the direction of things and disappointment about them. Think of it as two things: legitimate business risk and the fear of regret. Uncertainty is more the fear of regret in that opportunities pursued will not yield their original desired result. If someone wants to build a manufacturing plant, and has great hopes to do so, their ability to forecast future demand and future prices and costs is essential. The fact that some of those items might not be what you want is not uncertainty, but is often characterized in the media as uncertainty. Future tax rates on capital are known. Future demographics are long term patterns that are known. The regulatory environment and its direction is known. All of these assumptions show up in the heads and on paper of investors as they run scenarios of the net present value of future investments.

    More sluggish growth to come. True Federal government debt obligations using GAAP accounting in the way large businesses must, is about $85 trillion (this is Fed data, not mine). That can only be paid for by increases in output and productivity. While the US is not Japan, a US population growth rate of just under 1% barely makes a dent, and neither does 2% real GDP growth. Interest rates below inflation discourage investment and savings, and encourage debt restructuring. Investment becomes directed to efficiencies of current processes and not broad innovation. There is currently little political interest in changing these baselines. Both political parties have had these interests in the past, but neither display them now.

  10. By David Schwartzbaum on Feb 15, 2014 | Reply

    While your numerical analysis is spot on as always, I think there is still something missing. There is a qualitative discrepancy in this country that I just can’t put my finger on. We know that unemployment rates have dropped “officially”, but the labor participation rate has dropped at the same time. There also seems to be a fundamental shift away from the old Protestant work ethic that made our economy chug along for centuries to a more “what’s in it for me?” mentality.

    College grads can’t find jobs, and if they do they are usually underemployed. So you have this big base of “replacement workers” that Japan is missing that are just as happy to be idly spending time at home with their helicopter parents. At my company, we have even had parents try to negotiate salaries for their kids! Sure, this is anecdotal, but I hear it from all quarters. And the work ethic is just not there.

    On top of that, people are not saving for retirement, and they are not preparing for the future, and the government continues to run up the deficit like a bunch of drunken sailors on shore leave. Add it all up and you have a recipe for disaster.