What are the chances of a recession? Not what you’d think.
Washington Post, April 3 2016
For at least five years, we have been hearing that the United States is on the verge of slipping into a recession.
Of course, it hasn’t — and probably won’t anytime soon. I’d like to talk about why that is and in the process look at how economic expansions end.
The National Bureau of Economic Research — the entity that determines the official start and finish dates of economic contractions in the United States — defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.”
Lakshman Achuthan of the Economic Cycle Research Institute (a friend and occasional lunch partner) adds an important qualifier to help understand the context of this economic data: He notes that for an indication of recession to occur, data must be “pronounced, pervasive and persistent” — not merely a temporary shortfall in one indicator or another.
I looked at the data going back to 1926. Historically, we see recessions occurring every 59 months (on average) over that period. This means the economy has been in a recession 18 percent of the time, with the average recession lasting a little more than a year. The post-World War II era — known as the great moderation — has experienced shorter and less frequent recessions. The amount of time the economy was in a recession has decreased. Occasional devastating financial crisis aside, the United States has matured to become a more advanced and (mostly) more stable economy.
All too many pundits seem to forget that. When we see a bad retail sales number in the midst of a blizzard, or a soft new-homes start number, the recession callers take to the airwaves. Their own terrible track records never seem to give them any pause.
We read that recession is “imminent” or “100 percent guaranteed in 2016” as two pundits declared recently. The language is not designed to inform or to describe probabilistic, data-driven models of a complex and nuanced global economy; rather, it is “look at me” talk and nothing more than marketing.
What are the supposed causes of this imminent recession? A few months ago, it was “illiquidity in the high-yield credit markets.” The next thing we heard was a China debt bomb, which was trotted out after China’s economy slowed and its market crashed. (Still no recession.) And then, earnings contractions and a strengthening U.S. dollar (last year, it was peak earnings and a weakening dollar). Let’s not forget the “Brexit” (British exit from the European Union), which apparently is this year’s version of the “Grexit” (Greece’s exit from the E.U.), which neither occurred nor caused a recession. We’ve had high oil prices, followed by low oil prices, each of which was supposedly fatal to the economic cycle (I guess for opposite reasons?). As of late, the biggest economic fear we hear about is the “rising political risk” of a Trump presidency.
All of it makes for great cocktail-party fodder but ignores how economic contractions typically occur:
All economies are cyclical; they start from the humble roots of the end of the prior contractions. They begin to expand when no one is looking and often ramp up despite widespread disbelief. The expansion slowly widens, affecting more regions and industries. It becomes modestly larger, slowly at first, then more robust, and while it should be increasingly difficult to deny that an expansion is occurring — at least judging by the data — plenty of people still manage to live in denial.
Maybe the economy stumbles once or twice before it picks up steam, reducing unemployment rolls to the bare minimum. Eventually, companies can no longer find new needed employees, so they begin raising wages to compete for workers. That leads to a leg up in hiring, bigger salaries and retail sales.
Most important of all to the cycle is the start of inflation. Once we see a few consecutive quarters of higher prices, the economy begins to overheat. This forces the Fed to pay attention and eventually to act. Fear of inflation scares the Fed into a tightening cycle; typically, it will tighten at three, four or even five meetings in a row. This reduces available credit, makes the credit that is available more expensive, and — voila! — a recession occurs.
We can create a basic checklist to tell when an economic expansion cycle has begun to have run its full course:
● Full employment (check)
● Wage gains (hardly present)
● Inflation (1.7 percent is far below recession levels)
● And last, an aggressive Federal Reserve tightening that takes interest rates too high. We are now at a mere 0.25 percent, perhaps going to 0.50 percent — hardly soul-crushing rates.
Thus, while we can easily imagine the necessary conditions for the beginnings of a recession, they are for the most part simply not present.
Not that these minor facts stop the doomsaying forecasters. Regular readers know the disdain I hold for most predictions, but to demonstrate this, try Googling “recession in 2015.” It generates these “scary” headlines and phrases:
● Fortune (Oct. 28, 2014): “The case for a global recession in 2015”
● Bloomberg (Nov. 10, 2014): “Predictors of ’29 crash see 65 percent chance of 2015 recession”
● CNBC (March 11, 2015): “Plunging oil prices and a strengthening dollar could force the United States into a recession by the end of 2015”
● The Economist (Sept. 9, 2015): “Global recession is the ‘most likely’ outcome for 2015.” (That followed an earlier headline (June 13, 2015) that said, “It is only a matter of time before the next recession strikes.”
Doing the same for “recession in 2014” yields the following:
● Reuters (Dec. 7, 2013): “Nobel economics winner Fama says risk of global recession in 2014”
● Politico (Oct. 4, 2013): “Recession looms in 2014”
You can find similar terrible forecasts for 2013 and prior years. It is beyond me why these folks still have jobs.
One day in the future, wages will increase, prices will begin to rise and, eventually, a Fed rate hike cycle will go too far. That is when this economic expansion cycle will end. In the meantime, the economy is expanding, housing is recovering, we are near full employment, and we are just starting to see some modest signs of wages moving higher. That suggests more savings and investment and perhaps an increase in retail spending.
Enjoy the economic expansion; it will end — just not as soon as the doomsayers believe.
Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture. On Twitter: @Ritholtz.
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