Slowdown, Recession, Or Full Speed Ahead?

This article was initially published on my website, Van Schaik’s Economic Outlook, on April 4, 2007. The economic model used to forecast the current recession is as valid today as it was then. You can see the current charts for the Business Cycle Indicator plus other economic data at http://jpetervanschaik.googlepages.com .

April 4, 2007

Slowdown, Recession, or FULL SPEED AHEAD? The debate continues: The financial networks are whispering the S-word and the R-word; Alan Greenspan says we have a 30% chance of sliding into a recession in 2007; stock markets around the world are experiencing some breathtaking falls; other analysts predict a mild slowdown before the economy comes roaring back. So what's it going to be? While we admit no one can know the future with any absolute certainty, we believe a recession is a high probability rather than a mere possibility. As Chart 1 indicates, our business cycle indicator has been negative since April 2005. Prior to each of the last 6 recessions, as defined by the National Bureau of Economic Research, it has turned negative from 9 to 23 months prior to the onset of the recession (marked in red), with an average lead of 14.7 months. The indicator, currently at -4.87, hasn't been as low since May 1981 when it hit -5.2, two months before the onset of the 1981-'82 recession. It has been lower only three times in the last 45 years. The data in the chart are based solely on interest rates. While recessions are frequently attributed to other factors, such as rising oil prices, our research over the last 30 years indicates interest rates are the most accurate indicator of turning points in the business cycle. Of course, all prices, including oil, are influenced by interest rates and interest rates are influenced by all prices. However it is our opinion that interest rates are the primary mover regarding business cycles. The cumulative values of the negative figures, as shown in Chart 2, are most accurate in forecasting the recession's length. Chart 3A shows the relationship between the cumulative total of the monthly figures and the length of the recession. The line is consistent with the exception of one outlier, the short recession of January to July 1980.

Regression analysis of the data results in the equation y= -.147x + 6.34 which indicates the recessions length where x is the cumulative total and y is the length of the recession in months. At the end of February the cumulative total was -73.2, lower than seen prior to or during any of the previous six recessions. This indicates the expected recession will last a minimum of 17 months since it is extremely unlikely it will turn positive anytime soon.

If you count the double dip recession of the early 1980's as one recession rather than two and chart the result in a scatter plot, the outlier is eliminated and a consistent line appears, as shown in Chart 3B. Regression analysis gives us y = -.18x + 6.57. That indicates a recession lasting at least 20 months. We admit past performance does not guarantee future success. However, at this point, we think the risk is definitely on the down side, for the economy in general and stocks specifically. While the bulls continue to surprise us with their ability to quickly shrug off any negative news and bid the market higher, economic reality will soon rule. The house that debt built will face its day of reckoning and the bulls won't be able to find the exit quick enough. Don't get caught in that stampede... - J. Peter Van Schaik