An Imminent Likelihood of Recession

The latest from John Hussman

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Jan 18, 2016
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Since October, the economic evidence has shifted from supporting a growing risk of recession, to a guarded expectation of recession, to the present conclusion that a U.S. recession is not only a risk but an imminent likelihood, awaiting confirmation that typically only emerges after a recession is actually in progress.

The reason the consensus of economists has never anticipated a recession is that so few distinguish between leading and lagging data so they incorrectly interpret the information available at the start of a recession as “mixed” when, placed in proper sequence, the evidence forms a single, coherent freight train.

While I’m among the only observers who anticipated oncoming recessions and market collapses in 2000 and 2007 (shifting to a constructive outlook in between), I also admittedly anticipated a recession in 2011-2012 that did not emerge. Understand my error so you don’t incorrectly dismiss the current evidence. Though not all of the components of our Recession Warning Composite were active in 2011-2012, I relied on an alternate criterion based on employment deterioration, which was later revised away, and I relied too little on confirmation from market action, which is the hinge between bubbles and crashes, between benign and recessionary deterioration in leading economic data and between Fed easing that supports speculation and Fed easing that merely accompanies a collapse.

Much of the disruption in the financial markets last week can be traced to data that continue to amplify the likelihood of recession. Remember the sequence. The earliest indications of an oncoming economic shift are observable in the financial markets, particularly in changes in the uniformity or divergence of broad market internals and widening or narrowing of credit spreads between debt securities of varying creditworthiness. The next indication comes from measures of what I’ve called “order surplus”: new orders plus backlogs minus inventories. When orders and backlogs are falling while inventories are rising, a slowdown in production typically follows. If an economic downturn is broad, “coincident” measures of supply and demand, such as industrial production and real retail sales, then slow at about the same time. Real income slows shortly thereafter. The last to move are employment indicators – starting with initial claims for unemployment, next payroll job growth and finally, the duration of unemployment.

Last week, following a long period of poor internals and weakening order surplus, we observed fresh declines in industrial production and retail sales. Industrial production has now also declined on a year-over-year basis. The weakness we presently observe is strongly associated with recession. The chart below (h/t Jeff Wilson) plots the cumulative number of month-over-month declines in Industrial Production during the preceding 12-month period, in data since 1919. Recessions are shaded. The current total of 10 (of a possible 12) month-over-month declines in Industrial Production has never been observed except in the context of a U.S. recession. Historically, as Dick Van Patten would say, eight is enough.

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A broad range of other leading measures, joined by deterioration in market action, point to the same conclusion that recession is now the dominant likelihood. Among confirming indicators that generally emerge fairly early once a recession has taken hold, we would be particularly attentive to the following: a sudden drop in consumer confidence about 20 points below its 12-month average (which would currently equate to a drop to the 75 level on the Conference Board measure), a decline in aggregate hours worked below its level three months prior, a year-over-year increase of about 20% in new claims for unemployment (which would currently equate to a level of about 340,000 weekly new claims) and slowing growth in real personal income.

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