THE CAKE IS BAKED

It’s been tempting to think that maybe, just maybe, the U.S. could avoid recession. Perhaps some divine financial power might intervene and pull the economic coals out of the fire. But such hope, however remote in the first place, should now be packaged away in the file cabinet that holds all forlorn desires.
The recession, by our reading, is confirmed. That will come as old news to readers of these digital pages and anyone else who follows the economic news. Any number of warning signs have been flashing for months, some of which we’ve discussed. Economic models, by contrast, often dispense robust signals with lags. That’s in part due to the fact that economic data is released with a lag. In addition, economic measurements that digest multiple data series are prone to false signals and a fair amount of volatility in the short term. The practical solution is to be patient and wait for a relatively high degree of confidence that the model’s warning is more than statistical noise. As such, our own home-grown index has just issued what we think is a valid signal after we updated the last bit of selected February data (personal spending and income). Yes, we’ve suspected contraction all along, but now we’re that much more confident.
Granted, absolute clarity in the dismal science is forever elusive–except in hindsight, when all the data’s been revised and economists have scrubbed and rescrubbed the numbers so that the only remaining debate centers on what size font to use for writing the definitive history. That day is still a ways off. Meanwhile, back here in real-time economics, replete with all the usual caveats, the cake looks pretty much baked by this editor’s reckoning. It’s now time to move on and debate, among other things, how long the recession will last, how deep it will be and what it all means for strategic-minded portfolio design.


Our analysis draws on a number of factors, including our proprietary benchmark (CS Economic Index, or CSEI hereafter) of economic trends broadly defined. As our chart below shows, the downturn is now unmistakable by our metric. The slippage, having started in November and running through February, is four months old, which is exceptionally long and consistent according to our model in recent history. Alas, our system of measuring the broader economy is vulnerable to false signals from time to time and so we’ve waited until the arrival of four consecutive monthly downturns so as to avoid (hopefully) jumping to rash conclusions. Having reached that threshold, we’re confident that the cycle has in fact turned. Again, that’s old news in many respects, but in our mind it represents closure in the debate.
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There are a number of other clues corroborating the four-quarter slippage in CSEI but for now we’ll simply note that ours is a view that uses a variety of indicators. Meantime, here’s a brief description of the index’s design.
CSEI is an equally weighted average of 13 indicators populated as follows: 7 leading indicators, 4 coincident indicators and 2 lagging indicators. Examples include the S&P 500, nonfarm payrolls and retail sales. In other words, it’s weighted in favor of leading indicators because for this metric we’re more interested in where we’re headed as opposed to where we’ve been. Easier said than done, of course, but that’s the thinking.
There’s nothing magic about the index and certainly it’s open to criticism on a number of levels, as is any one metric that seeks to condense something as complex and nuanced as the U.S. economy into a single data series. What’s more, your editor is fully aware that countless economic consultancies armed with teams of experts attempt to divine macroeconomic trends and have come up short. Suffice to say, economic forecasting is fraught with truckloads of risk, and more than average in regards to yours truly.
Nonetheless, about a year ago we embarked on a project to build an index that would provide a general reading of the trend in U.S. economic activity. The choice of simplicity in design offers the benefit of transparency while the blending of indicators profiling varying aspects of economic activity holds a degree of promise for minimizing the noise that routinely infects any one data series. Nonetheless, there can be no guarantee that some other variable not included in the index will prove to be crucial. In fact, we’re sure of it.
Despite the caveats, we keep studying the numbers, including today’s update on personal income and spending, which are included in CSEI. Notably, personal income rose by a solid 0.5% in February, up from 0.3% in January. That’s encouraging, although the more relevant metric for the economy outlook in the months ahead is how much of the income is being spent. By that standard, the trend offers more reason to think that economic contraction is real. Personal consumption expenditures (PCE) rose by a scant 0.1% last month, down from January’s 0.4%. After adjusting for inflation, PCE was flat in February. Meanwhile, the general trend in real PCE, based on a 12-month rolling average, is unmistakably down, as our second chart below shows.
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Meanwhile, the Federal Reserve is moving heaven and earth in an effort to contain the pain of the cycle. The central bank will surely have some success, but it’s not clear that this time around the success will live up to the high expectations set by previous recoveries. Indeed, for the moment, the recent liquidity injections have yet to stem the tide of slowdown. In addition, it gives us pause that the Fed has been early in the cycle in delivering its monetary medicine and still the patient remains wobbly. And at some point, the injections must end, perhaps earlier than expected depending on inflation’s future path. If so, the recovery may disappoint. But we’re getting ahead of ourselves. For now, it’s all about monitoring the contraction.