Now that the Recession is Over, What's Next?

Now that the US recession has officially been declared as being over, the most obvious and pressing question is where we go from here?

As there are confusions about what a recession or recovery actually means (see the previous post), there are just as many confusions concerning whether we are actually in a recovery or a recession. I have provided a chart that will help to illustrate this point (click the chart to enlarge it).

I think it is safe to say that generally, most people refuse to believe the pronouncements of economists concerning when an economy is in the very early stages of either recession or recovery. Consider early recession in the chart. Note that the economy is not very far from its peak in economic activity. So, when economic data are released, the numbers are still very good in a historical context. In fact, unless you focus on what economists refer to as leading economic indicators, the numbers will show an economy that is still climbing the activity "hill" (i.e., to the left of the peak), making it even more difficult to assess what is actually taking place. Perhaps the best example of this is the one measure the general population focuses on most -- the unemployment rate. This is a lagging indicator, meaning its level at present reflects what happened in months past. Remember: a recession is NOT defined as a level of diminished economic activity. As the National Bureau of Economic Research (the "dating" body for economic cycles) points out, it is instead a period of diminishing activity. This highlights the distinction between levels and rates of change that I discussed in the previous post.

Right now, nationally at least, we find ourselves in the early stages of a recovery. Once again, look at the chart above. In the early stages of a recovery, an economy is close to the "bottom" of economic activity. The numbers that are released are therefore not going to be very good, and after a recession period, often discouraging. Of course, if you focus on lagging indicators, you will almost certainly conclude that we are still in a recession.

At this point, I need to reiterate that contrary to popular "wisdom," being in a recovery does not necessarily require a return to "normal" times and historical averages (or above) of economic variables. It might. But generally it takes some time to get back to "typical" levels. The next chart will help to explain this.

As this chart should illustrate, not all recoveries are alike. Each path reflects how rapidly economic activity will be rising in the future. Historically, when there is a very deep national recession like the one we just had, the economy rebounds quickly. This leads to a "V" shaped recovery (the green line). It doesn't take all that long to return to "normal" levels of economic activity. In that situation, a recovery feels like a recovery.

But recovery paths are different since not all recessions are the same. Global recessions occur over longer periods and are generally more damaging than more "typical" recessions. When there is a global recession with major financial problems, as the one we just had, the pace of recovery tends to be slow and it takes a longer time to return to "normal" levels of economic activity (the red line). Consider that at present, individuals are spending less, saving, and paying down debt. Banks have lowered leverage. All of this is very positive in the medium to longer term, but it extracts a cost on the rate of economic growth in the short term. Add to this  the fact that banks aren't lending as much as they might have in previous recoveries, and you get what Mohammed El-Erian of Pimco refers to as "The New Normal" (click here for a video of El-Erian explaining this concept). He and I are somewhat concerned with the possibility of deflation in the near-term as well.

So, where does all of this leave us? What are you to think? Hopefully you are now more aware of  the basics of what is really going on, what an early recovery means, and the possible paths the US economy might take. THE question is which path will be the one our economy follows. Let me be very honest about this: economists, including me, don't really know the answer to this, in spite of all our forecasts and predictions. In this context, let me state one of my favorite sayings: CERTAINTY IS AN ILLUSION. Any forecast, no matter who makes it, is essentially a scenario. It assumes what the areas are that will be the most important over the forecast period, how each of those areas will actually change, and the interactions between and among them. Obviously, there are numerous sources of potential error.

In a period of such uncertainty, where things seldom appear to be what they actually are, many persons are all too willing to step forward with their "solutions." While these might sound good, or appeal to the increasingly subjective notion of "common sense," they too are based on scenarios. So, they might be right. Or, they might be wrong. Let me recommend that you critique any or all of these within the context of one of my favorite sayings: "Complex problems have simple, easy to understand, wrong answers."

Let me finish by acknowledging that at this point you are no doubt wondering where I stand on the future path of economic growth. I will outline this in the coming days (it's time for me to get to class). Before doing that, I need to apply the information in these last two posts to what is occurring in Rhode Island. Stay tuned!

February's Employment Report

February's employment report was better than expected. Even though there was a loss of 36,000 jobs, weather factors had been fully expected to exacerbate the final number. More importantly, when weather-distorted values of employment such as February occur, the jobs number in the following month almost always shows a significant rise, as some of the weather-related loss is "made up." This is clearly the expectation going forward, that March will show a rise in employment (not just because of the addition of Census workers). The unemployment rate remained at 9.7 percent, also better than anticipated, leading some to conjecture that we have already. Gseen the peak unemployment rate (I am not convinced of this yet). Here is an article about the report, and two videos from CNBC about the employment report. The first is pre-report, the second occurred after the data were released. The bond market hated the employment news, selling off, as the 10-year bond rose 8 basis points (remember: when bond prices fall, interest rates rise).

Most of the time, when an employment number is released, the stock market tends to bounce around, as bulls and bears battle throughout the day. Generally, this leads to a small daily change for the market that day. This was not the case on Friday, as the market shot higher and sustained its momentum throughout the trading day. The result was a large candle, a large real body, and almost no shadow (tails). Here is the chart for Friday (click to enlarge). Note that resistance in terms of the RSI(9) remains above 60, but it is now slightly overbought. So, will we make it to the next resistance at 1150 without a short-term pullback? Check next week's economic releases and see if there are any major releases that can materially affect the stock market.

 I believe that the stock market sustained its earlier momentum as the day wore on because in addition to the jobs report, there was a report that consumer credit had risen, painting a potential picture of how a recovery will gain traction. Of course, time will tell if that perception turns out to be correct, but I believe the market is pricing this in.

There was a good video on CNBC that discusses sectors (a bit) and the interest rate to look at (2-year US Treasury) as a signal that the market will break out from its recent sideways action.

Finally, I didn't mention it in class Thursday, since I want to see who reads the blog postings, but our exam will be on Tuesday, March 16. So, dig in, do the assignment, and study for the upcoming exam.

January Employment Report

 Friday's employment report was multifaceted, to say the least. First, there were the employment change results: -20,000 (a very small amount for the entire country, and not statistically significant). Then there were the employment revisions for 2009 -- very large, making the job loss during "The Great Recession" equal to 8.4 million. Finally, there was the unemployment rate, which fell from 10 percent to 9.7 percent. Recommendation: ALWAYS LOOK AT REVISIONS TO PRIOR PERIOD(S) BEFORE EXAMINING THE NEW DATA (as this establishes a proper context for you).

Much was written about these results. Here's what the WSJ said. Here is the link for a video from CNBC after the results were announced, and another link for the same group discussing things before the release. After reviewing all of these,make sure you understand: (1) that there are two separate surveys used for these results; (2) how can the unemployment rate actually fall if employment falls; and (3) what are the implications of the set of results for the stock market, bond market (interest rates), and the US dollar. As I have said numerous times already this semester, "other things" are seldom "equal." So, as a backdrop to all of this information from Europe, is the ongoing concern about the Sovereign debt of Spain, Ireland, and Portugal (these countries have now come to be referred to as the "PIG" countries). So, the final outcome of the day was the joint effect of the Sovereign debt problems and the US employment/unemployment rate data.

January Employment Report

Friday's employment report was very close to my expectations -- very bad. As I stated in class on Thursday, my expectations were for payroll employment to fall by 550,000 and the unemployment rate to rise to 7.7%. The actual employment change was -598,000 and the jobless rate rose to (only) 7.6 percent. Read a story about this report. Also, view a video, the Short View by John Authers of Financial Times.

Reaction by markets was very likely the opposite of what you had come to expect. I will focus on only the stock and bond markets in this post.

The stock market actually rose by 217 points. There are a couple of reasons for this. There is a formal expectation for major numbers and what is called a "whisper number" -- what markets really expect and have braced for. The whisper number for employment was a decline of over 600,000, so the actual number was not much of a surprise (or scare). The whisper number for the unemployment rate was around 7.8%. So, in a sense Friday's stock market rally was a sigh of relief -- we apparently have dodged a bullet. But there is another level of causation involved.

The January numbers were so bad that markets have now discounted for the fact that some stimulus package will definitely pass -- and soon. Furthermore, Treasury Secretary Geithner is expected to announce a new round for TARP funding, and as of Friday, markets reacted to the "rumor" (their visions of what will likely occur) as they so often do. But there is a very old saying in the stock market: Buy on the rumor, sell on the news. So, when the actual details of the Treasury program are eventually released, apparently on Tuesday, expect there to be somewhat of a letdown, as reality seldom matches expectations, potentially resulting in some stock market giveback.

Technical analysis tools help in evaluating the likelihood of this. First, the RSI(9) for the Dow-Jones Industrial Average ($INDU in StockCharts.com) just moved over 50 on Friday, a bullish sign, and nowhere near an overbought reading (at 70). But, a look at recent highs in late January indicates that there is resistance point not far from where the market closed for the week. So, we have a toss up based on technicals.

What about the bond market? Review the online notes from Thursday. Interest rates rose on the "good" news, which means the bond market sold off (lower bond prices). Persons sold bonds, which lowered bond prices and raised interest rates, and moved into stocks, raising stock prices. This is a very typical "rotation, the reverse of a flight to safety. The ten-year US government bond rate rose to almost 3%, which is stunning since about a month ago it was threatening to break below 2%.

If we assume, as is quite possibly the case, that interest rates have bottomed, then bond prices will be falling from this point forward. If you were an investor, how could you "play" this expectation? There are inverse Exchange Traded Funds (ETF's). For bond prices, the symbol is TBT, the double inverse (i.e., ultra short) for 20+ year bonds. Check this out and graph it on StockCharts.com. Is there a trend? If so, which direction? Where is support? Resistance? What do the RSI and relative strength indicate? Please note: I AM NOT RECOMMENDING THE PURCHASE OF THIS ETF.

As I finish this post (11:30pm Sunday night), the Dow-Jones futures are signalling an opening that is down about 92 points from Friday's close. This might well change. But keep an eye on markets after the Treasury announcement on Tuesday.

August Employment Report

On Friday, the government reported another decline in monthly (payroll) employment. This time the decline was 84,000. Weakness was greater than this number appeared to show, since prior months saw employment revised lower (ex: June went from -51,000 to -100,000, the first six-digit decrease since the recent declines began). Along with this the unemployment rate rose by a greater-than-expected amount, from 5.7% in July to 6.1% in August, its highest level in over four years.

As we haven't yet started with our topical coverage yet, I will refer you to an article dealing with this labor market report. Also, read the relevant chapter for this in the course text The Atlas of Economic Indicators. Finally, let me point out two things for you keep in mind as the semester progresses:

#1: When studying new data for an economic indicator, ALWAYS LOOK AT REVISIONS TO PRIOR PERIODS BEFORE EVALUATING THE CHANGE FOR THE CURRENT PERIOD (this puts the current change it into the correct context); and
#2: The overwhelming majority of media coverage from this report centered on the unemployment rate, which as I indicated on Thursday, IS A LAGGING INDICATOR.

I will leave it to you to figure out whether the media is actually basing its assessments of future economic activity on this lagging indicator.

Employment Report -- March

Yesterday the March employment report was released. To the surprise of many (including me), payroll employment rose by 180,000 over the February total. This was far above the consensus estimate of around 130,000. Ironically, there was no effect whatsoever upon the stock market. Of course, that's because the markets were closed the day the report was released. So, Monday should start off with a bang, as traders have had the entire weekend to think about their reaction to the report.

Part of the reason for a larger-than-expected employment gain was that when the February survey was undertaken there was a snow storm, which prevented some persons from getting to work during that week. THE EMPLOYMENT SURVEY IS CONDUCTED DURING THE WEEK THAT INCLUDES THE 12TH OF EACH MONTH. So, comparing to a month with snow storms leads to some distortions. February likely understated employment, and March, comparing to February, overstated employment strength. While the employment data are seasonally adjusted (a statistical smoothing that takes into account events that happen "normally" at the same point each year), atypical events -- like February's snow storm, often cause seasonal adjustment distortions. A very readable article describing seasonal adjustment in on the online syllabus. Access it here.

So, while we have to wait until Monday to see how the employment report will affect the stock and bond markets, there was a great deal of discussion about the report overall and its likely asset market effects on television Friday. One question that is emerging about "good news" is whether the stock market will react positively or negatively at the present time. Why? Because "good news" may signal the increased likelihood of Fed tightening. And, we saw earlier in the semester, that rising interest rates are bad for stock prices (often referred to as a "head wind"). But, a stronger economy means profit strength in the future, which is a plus for stock prices. So, which effect will predominate with investors? Stay tuned, we'll see. Here's a Friday article that discusses this. Let's see how accurate it proves to be.

Along with employment, the monthly labor market report also has information on the unemployment rate, which fell unexpectedly from 4.6% to 4.4%, placing us at full employment, an average hourly wage growth. Often this is taken to be an inflation indicator, but it really isn't that good at signaling future inflation (here's an article discussing that). Actual wage growth was 0.3%, the expected amount, so there is not likely to be any reaction to that aspect of the report. As I stated in class, there are composition effects to wage change, determined by the types of jobs that are added in a given month. If lots of "high wage" jobs are added, the wage gain will be substantial. If largely "low wage" jobs are added, the opposite occurs.

So, what is happening to inflation expectations? Has the employment report changed anything? I have shown a way to observe this using StockCharts.com and TIPS prices relative to bond prices. For extra credit, graph this ratio (which we have discussed in class before) using daily data (make it a line graph). Annotate this with comments, print it and add a paragraph of discussion, and hand this in at the beginning of class on Tuesday. I will not accept anything after the beginning of class.

So, Monday morning promises to be very interesting for the stock, bond, and currency markets. It would be very good practice for you to think of what "should" happen, based on economic theory.