ISM's Non-Manufacturing Report Suggests U.S. may not yet be in a Recession

The Institute for Supply Management released their February 2008 Non-Manufacturing ISM Report on Business today.

The Non-Manufacturing Index (NMI) rose 4.7% to 49.3% up from 44.6% in January. Readings below 50 indicate that the non-manufacturing sector is generally contracting. Economists had forecasted that the NMI would rise to 47.3%.

Here is what some of the Respondents had to say:

• "Business remains strong in 2008 despite signs of an economic downturn." (Professional, Scientific & Technical Services)
  
• "January was a very slow month and February has started off at the same pace." (Wholesale Trade)
  
• "Business drops significantly as we move away from the holiday season." (Retail Trade)
  
• "Weakness continues in both volume and pricing." (Agriculture, Forestry, Fishing & Hunting)
  
• "Financial services companies are beginning to stabilize from the effects of the subprime market issues, but overall will continue to focus on business as usual by increasing productivity of current workforce and supply base and limit any increases at this time." (Finance & Insurance)

This was a strong reversal today and adds further evidence that we may not yet be in a recession. During the 2001 recession, NMI was below 50 9 out of 10 months from April 2001 to January 2002. It averaged 48.3 during that period.

Bespoke Investment Group posted a chart on the odds that the U.S. will enter a recession in 2008 (measured by Intrade contracts and defined as 2 consecutive quarters of negative GDP growth). The odds have declined from a peak of 77.5% to current odds of 59%.

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Peaks and Troughs during Recessions

Last week, Calculated Risk had a great post taking a look at market corrections during recessions.


Calculated Risk graphed the change from the three year daily high and the monthly close. Here is his graph for the Dow going back to 1930. Here is his graph for the S&P 500 going back to 1951.


The downside is dramatic; however even more dramatic is the recovery after. Here are two graphs showing the changes from the three year daily highs and lows.
Here is a table showing the gains and losses from the tops and bottoms:




I am reminded of what a Japanese fund manager said after the massive two day declines at the beginning of last week (the Nikkei 225 went down 9.29% in those two days): "We will be buying back on value shares later today since we don't want to get slapped on both sides of the face...selling more than we should and failing to catch up when the market recaptures momentum."

The American Association of Individual Investors (AAII) publishes a sentiment survey measuring the percentage of individual investors who are bullish, bearish, and neutral on the stock market short term.

In September of 2000, the S&P 500 hit its high right during the internet stock bubble before the 2001 recession. The AAII sentiment survey was very bullish. In the beginning of September 2000, 62.5% were bullish, 29.2% were neutral and 8.3% were bearish.

In October of 2002, the S&P 500 hit its low after the 2001 recession. In October of 2002, the AAII sentiment survey was at the most bearish level in 11 years. 28.9% were bullish, 16.4% were neutral, and 54.8% were bearish.

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Recessions

Now that some of the major Wall Street firms are predicting we have entered into a recession, I thought I would take a closer look at recessions. Per Wikipedia, a recession is defined as ”a decline in any country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year.”

In the U.S., the National Bureau of Economic Research(NBER) officially dates the recessions. Here is their definition: A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.

The NBER typically declares that a recession has started 6 to 18 months after the beginning of a recession. At the time, it is often tough to tell if the economy has tipped into a recession. We won’t see the advance GDP numbers for 4th quarter 2007, until January 30, 2008. The numbers for January through March wont be announced until the end of April.

Calculated Risk had dug up these classic quotes on the 1990 recession.

“In the very near term there’s little evidence that I can see to suggest the economy is tilting over [into recession].” Greenspan, July 1990

“...those who argue that we are already in a recession I think are reasonably certain to be wrong.” Greenspan, August 1990

“... the economy has not yet slipped into recession.” Greenspan, October 1990

The recession was declared by the NBER to have started in July 1990. By October 1990, the S & P 500 was close to the bottom. By the time it was obvious we were in a recession, the bottom had already been reached.

Despite the inherit murkiness of recessions, I will take the liberty of creating these graphs with the clarity of hindsight vision. You can click on the graphs for a larger view.

>We have had 10 recessions going back to 1948. The average recession has lasted 10.4 months. The average return on the S & P 500 from the start of the recession to the end of the recession has been -0.57%. In 6 out of the 10 recessions, the S & P 500 was higher at the end of the recession rather than the beginning of the recession. However, during the last 10 recessions, the S & P 500 did decline 13.6% from the beginning of the recession to the low reached during the recession. Note that the S & P 500 figures do not reflect the highs and lows that the S & P 500 traded at on a daily basis during the month; my figures just reflect the closing price for the month. The low was reached on average 6.8 months after the start of the recession. From the low during the recession to the subsequent high, the S & P 500 has gained an average of 35.1%.
There have been 3 instances of what I have termed false bottoms in the first or second month of a recession. In the last 10 recessioins ,there was never a real bottom that early. There have been 2 recessions in the last 10 years where the low was reached at the third month, the rest have been later. This is partly due to the fact that recessions are normally thought of as lasting at least 2 quarters. If the economy recovers in a few months (bottom is reached in the first or second month), then the period most likely would not be defined as a recession.

Finally, for a different perspective, I am also including the charts for the Great Depression, the recessions of 1937 and 1945, and finally the most sobering of all: the Japanese bubble.

I plan to revisit this topic from time to time.

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Merrill Lynch declares we have entered in recession.

David Rosenberg, chief North American economist for Merrill Lynch, announced: "According to our analysis, this [recession] isn't even a forecast any more but is a present day reality."

Marketwatch reports:

"Friday's employment report strongly suggests that an official recession has arrived," Rosenberg wrote in a note to clients on Monday.

"The key question now is how deep the recession will be and how long it will last," wrote Richard Berner and David Greenlaw, economists for Morgan Stanley, in a note to clients on Monday.

According to the Telegraph:

Mr Rosenberg points to a whole batch of negative data to support his analysis, including the four key barometers used by the National Bureau of Economic Research (NEBR) - employment, real personal income, industrial production, and real sales activity in retail and manufacturing.

Mr Rosenberg notes that although the NEBR will be the final arbiter of any recession, such confirmation may be two years away as it typically waits for conclusive evidence including benchmark revisions.

However, he believes that all four of these barometers "seem to have peaked around the November-December period, strongly suggesting that we are actually into the first month of a recession."

The Big Picture posted this graph:



Here are some Rosenberg quotes from the Jay Hancock's blog at the Baltimore Sun:

At no time in the past sixty years has the unemployment rate risen 60 basis points (50 bps is the actual cutoff) from the cycle low without the economy slipping into recession, and here we now have the jobless rate hitting 5% in December versus the March/07 trough of 4.4%.

Aggregate hours worked in the economy contracted at a 0.4% annual rate in 4Q, and this comes on the heels of a 0.6% decline in 3Q. Back-to-back declines in total hours worked have always been associated with recession.

The level of unemployment is up 13% YoY, again a development that has always been consistent with past recessions. The YoY rate of change in the level of the unemployed who have been idle for at least 15 weeks is particularly ominous - +20%, which is a pace that prevailed in the early stages of prior economic downturns (hitting this trend in April/01 and in Aug/90 when the recessions were one-month old).

And we have Household Employment contracting 49,000 in 4Q and the YoY trend lowing to +0.2% in December from +2.2% a year ago, another classic recession signal. Consider for a second that in March of 2001 that trend was running at +0.8%, and in July of 1990 the pace was +1.1% - those two months represented the onset of a technical recession and yet the trend in Household jobs is weaker now than it was then.

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Residential Investment and Recessions

Calculated Risk has a great post on some of the components of GDP and their relation to recessions.

His first chart looks at Private Fixed Investment. You can click on it for a larger image. He notes that “Private fixed investment has fallen 13 times since 1948 (14 including the current slump), with only 10 recessions.” He comments that in the dips in 1951, 1967, and the minor slump in 1986, private investment fell, but the economy didn't slide into recession. However, each time was accompanied with a surge in defense spending with the Korean war, the Vietnam war, and the general defense build-up with the Cold War.


Here is a chart with Defense Spending.The Defense Spending in the first quarter of 1951 through the second quarter of 1952 was off the chart (65% in the first quarter, 98%, 118%, 111%, 75%, and 47% in the 2nd quarter of 1952).
Calculated Risk points out that “the year-over-year change in private fixed investment appeared to have bottomed in early 2007, suggesting the economy might have avoided a recession”. Currently our Defense spending is up helping to cushion the drop in fixed investment. But Defense spending is not up at the high levels it was at during the previous wars.

Calculated Risk created a second graph separating private fixed investment into residential and nonresidential components. He illustrates that in general “residential investment leads nonresidential investment.” If residential investment continues to fall, it suggests that nonresidential fixed investment would also fall.

Calculated Risk also has good charts on residential investment compared to equipment and software investment and also compared to structures. Both those components of GDP tend to lag residential investment.



Edward Leamer, a Professor at UCLA, presented “Housing is the Business Cycle” at the Housing, Housing Finance, and Monetary Policy Symposium sponsored by the Fed in August 2007. In his presentation, he noted some of the same dynamics.

“Residential investment consistently and substantially contributes to weakness
before the recessions, but business investment in equipment and software does
not. And the recovery for residences begins earlier and is complete earlier than
the recovery for equipment and software.”

Residential investment “contributes most to weakness before recessions. In 6 of
the 10 recessions, residential investment was the greatest contributor to
weakness prior to the recession. Only twice of 10 did residential investment not
contribute significantly to weakness prior to the recession: the 1953 and 2001
oddballs. “

Consumer durables, consumer services, and then consumer non-durables were the next significant contributers.

"Equipment and software ranks as the number one source of weakness during the
recessions compared to a rank of six prior to the recessions. In terms of their
impacts during recessions, after business spending on equipment and software
came consumer spending on durable and nondurables."

Leamer said that after residential investment, the next best predictor of recessions is consumer durables and consumer services. Here are graphs of each.

Neither consumer durables or consumer services dipped in the 3rd quarter of 2007. The 4th quarter 2007 GDP figures are due to be released on January 30, 2008.

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