Recession (Unofficially) Over

Even though the economy hasn't been given the official 'all clear,' data confirm the contraction is over.

Robert Johnson, CFA 25.09.2009
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The determination of when a recession ends is made by the National Bureau of Economic Research (NBER). Although I don't believe they formally disclose how they make their decision, it is widely believed that they use four key indicators:

* Industrial Production
* Retail Sales
* Employment
* Real Income

Industrial production and retail sales are both positive, and based on my estimates, real incomes barely turned positive last month and are likely to be even more positive this month.

Employment is still down, and we probably have two or three months before the economy manages to eke out a few job gains. So in my

opinion, the recession is likely to be declared officially over as of June or July with three of the four indicators positive and the last one making great progress. However, the NBER is usually quite conservative about declaring the official end of the recession, often fearing a second down-leg in the economy. It was almost a year after the end of the last recession before the NBER officially declared it over.

Besides the psychological benefit of an "official" start of the recovery, I expect to see one tangible benefit, a positive gross domestic product for the September quarter. I am anticipating growth of 3.5%-4.5% for the quarter and about the same in the fourth quarter. Based on the ramp-up in industrial production, I am anticipating that job growth will turn positive by year-end, and I am feeling increasingly confident that unemployment could peak by year-end.

Consumer Comeback
The consensus seems to be that economic growth will be very sluggish as a shell-shocked, debt-laden consumer refuses to part with any cash. I am in the more bullish camp that believes inventories and production fell to unsustainably low levels, and we have a strong shot at a robust economy over the next year. Auto purchases fell to half-peak levels, and actual production even fell below that. For most of 2009, the U.S. economy did not produce enough cars to meet the paltry sales of 2009. Inventories were relentlessly drained every month. That means production has to go up, even without the stimulus from the "cash for clunkers" program. The restart of auto production helped drive industrial production up 0.8% in August and 1.0% in July, both of which were well above expectations when reported this week.

Where did consumers get the cash to buy all these cars? A couple of ways. First, contrary to popular opinion, not everyone in America is up to their eyeballs in debt. Half the people in this country who own a home have no mortgage or have a very tiny remaining balance. Just as it was an error at the top to ignore the number of individuals in dire financial shape who toppled the system, it is just as silly to ignore the number of people in decent financial shape at the bottom who can come to our rescue. Did you notice this when the "cash for clunkers" program was in the spotlight each and every night for a month: I didn't hear one story--not one--about consumers unable to trade in their clunkers because they couldn't get a loan.

Also, the consumer balance sheet showed some nice improvement this week when the Federal Reserve released its Z1 report. Consumer net worth for June 2009 increased from $51 trillion to $53 trillion, still well down from its high of over $63 trillion a couple of years ago. Given several months of better real estate numbers and a significantly better stock market, it wouldn't surprise me if the consumer balance sheet number for September increased to $56 trillion or so, meaning we are getting close to recouping 50% or more of our losses. Recall the market, as measured by the S&P 500, is now up more than 60% from its low in March. Some of this newfound wealth may trickle back into the spending of the skittish high-end consumer.

In general, it looks like the consumer is feeling better. The dreaded retail sales report for August showed a nice increase of 2.7%, led by the "cash for clunkers" program and auto sales. This is the biggest advance since 2006 and compares with a small decline for July. Even without autos, sales were up 1.1%, and almost every category, with the exception of furniture and building materials, showed a month-over-month improvement. For the first time in many months, the number was better than expected, and the improvements were broad-based. Given that initial unemployment claims fell again (by 12,000 to 545,000), hours worked and average hourly wages have shown some signs of life, and the stock market has perked up, we expect the consumer to finally make some headway.

The Dark Clouds Remaining
What is keeping me awake at night? The most obvious worries continue to be commercial real estate and associated loans. A new wave of residential foreclosures, primarily on a fancy type of mortgage known as option arms, also looms on the horizon. However, some of the resets on these loans could be a little less onerous than expected as short-term interest rates are actually below where they were when many of these loans were made. Additionally, some of these homes may already have been foreclosed on, sold, or had the keys returned.

However, what really keeps me awake is that corporations continue to press their advantage on both consumers and employees just a little too hard. More sophisticated inventory systems and a willingness for corporations to lose volumes have led to fewer discounts for consumers than many had anticipated. Instead of serving up a nice discount on a better-grade product, some corporations are serving up lower-grade goods at list price. Consumers aren't biting. A restaurant offering a half-size, obviously skimpy portion, at half the price quickly had to scuttle the offering because of the poor response. A packaging of an appetizer, entree, and a dessert for one relatively attractive price was far more successful. Consumers know a bargain when they see it, as evidenced in the wildly successful "cash for clunkers" program. However, most business school programs talk of protecting the brand and not setting up expectations of incessant discounting. However, these aren't necessarily normal times, and a total focus on margins and disdain for any type of creative discounting for goods that consumers really want might be misplaced.

In weeks past, I have also talked extensively about productivity gains. However, at some point employees are going to rebel at all the extra work and diminished pay. And if not direct rebellion, low staffing (or low inventories on the consumer side) could cause companies to lose business. Frankly, the corporations need to share the wealth. I am optimistic on this front as a Watson Wyatt survey revealed that every month more companies are setting plans to reinstate 401(k) matches and turn back salary cuts. The survey even spoke of merit raises in 2010 in excess of 3% compared with 2% or less in 2009.

On Tap
Next week brings a big batch of housing numbers that continue to be important, though seasonality will start working against us shortly. Durable goods orders are also due, which should show some nice improvement. More consumer sentiment numbers are also due, though these figures are less important than they used to be as more positive trends become directly measurable (such as retail sales) instead of via a survey of intentions.

See More Articles by Robert Johnson

Robert Johnson, CFA, is associate director of economic analysis with Morningstar.

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Robert Johnson, CFA  Robert Johnson, CFA, is Director of Economic Analysis with Morningstar.

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