Is the US Headed Toward Recession?

Aftershock Newsletter

July 2012

Is the US Headed Toward Recession?

Last month we discussed some of the indicators of a major economic slowdown around the world, but what about the US? So far we have avoided a severe downturn, although we are clearly slowing down. But, how much further will this slow down go and could we actually enter a recession? Well, even now we find ourselves awfully close to recession. Recent estimates put growth in GDP during the second quarter at an annual rate of just over 1 percent. That's a big disappointment after earlier forecasts projected a 3 percent growth rate and the cheerleaders were announcing the recovery.

So the big question many people are asking is: Will we rebound in the second half of this year, or will the slow-down continue?

In order to answer that question, we first need to understand the reason the economy has been growing in the first place. And the reason, of course, is massive government stimulation, both through deficit spending and money printing.

The problem—for the nearsighted cheerleaders, anyway—is that both deficit spending and money printing have slowed. We still have a huge deficit, of course, but in order to keep stimulating the economy, deficit spending needs to be consistently growing, and that hasn't happened. Instead, the deficit has actually declined somewhat. In the meantime, we haven't seen another round of money printing (QE), which means the money supply has actually been pretty stable for the past year, after growing at an unprecedented rate in the years following the 2008 financial crisis.

The other problem for the US economy, as we explained in our earlier newsletter about deteriorating trends around the world, is that the rest of the world is slowing down too. From China to Europe to emerging markets, the trend is down, and this has major implications for the US in the immediate future. (It’s worth noting that a big part of the reason for the slowdown in China and Europe is the same as in the US: a slowdown in government stimulus.)

Without the stimulus that was fueling economic growth, and with trading partners contracting, the trend for the US is likely down. And the numbers bear this out. The Weekly Leading Index from the Economic Cycle Research Institute (ECRI) has us already in recession. As we mentioned in our last newsletter, the ISM manufacturing index, an excellent leading indicator, went negative recently for the first time since the last recession in 2009. The Philadelphia Fed's business-outlook survey sits at a disappointing negative 12.9. And retail sales have been negative for the last three months, and trending lower since February. Meanwhile, corporate profits have been declining, which means employment is likely to follow.

But, many people are ignoring these signs of recession and saying that a rebound is underway and will take hold in the second half. Of course, did these same people predict the current slowdown? Of course not, but many people still like to listen to what they say.

And, what are they saying to encourage us to ignore the recessionary signs and talk about recovery instead? They’re telling us to focus on little green shoots (sound familiar?) in particular, positive recent trends in housing and automobiles. In the case of housing, there is an uptick in new home construction of over 20% since last year. But, when you put it in a longer term perspective, as shown in the chart on housing starts since the 1960s below, it doesn’t look quite as impressive. Of course, it’s still an uptick.

Auto sales are also up almost 20% versus the same time last year. However, much of the increase in auto sales is due to a big increase in sub-prime auto loans (almost 40% are now sub-prime) and channel stuffing by manufacturers. Channel stuffing helps sales figures look better because sales are recorded when cars leave the factory, not when they are sold to consumers. For example, dealers of GM cars are sitting on 70% more cars than they had in 2010.

Home sales are also being boosted by direct government actions including very, very low down payment FHA loans as well as a big slowdown in the rate of foreclosures. Record low mortgage rates guaranteed by the government are also helping a lot.

Of course, government stimuli can last for a while, as can sub-prime loans to car buyers. So, the trend in those industries could continue for a while. But, unfortunately they aren’t the only parts of the equation. These small upticks are not enough to quickly offset the overall trend toward recession in the economy. The only thing that could do that is more large scale government stimulus, such as big increases in deficit spending and money printing. We expect more money printing to come eventually, but it's not going to be tomorrow and it may not be before the November elections. A big increase in deficit spending is unlikely during the next year no matter who wins the White House.

So, even though we’re not tumbling toward recession—this is more of a slow crawl--there's little reason to believe the economy is going to have a big rebound in the second half. Instead, without big government stimulus, we’re likely on the road to recession, albeit a slow road. And of course, there’s one reason we can be almost certain we're headed for recession: Ben Bernanke says we're not!