Sunday, August 16, 2009

Assessing the Recession

This is most likely the third worst economic period in modern United States History (accurate information isn't available for the 1700s and 1800s.) If, in fact, as I have been predicting and the data seems to be showing, we are either at the end or near the end of the recession, now is a good time to look at the historical place it holds.

Let's look at the 3 major metrics worthy of consideration: economic growth, unemployment and stock market performance.

These 3 metrics measure very different things.

Economic growth (or more accurately GDP contraction) is probably the purest metric - simply put, it measures the changes in the value of the output of our economy. A healthy economy would grow by at least 3-4% per year, enough to cover the growth in population and provide a modest increase in the average standard of living.

Unemployment is a key measure of the real pain that people feel in an economic downturn. It is important to track in addition to GDP contraction because some recessions that were not incredibly severe overall that led to a great deal of pain to the average person (case in point would be the 1981-1982 "double-dipper".)

The stock market, as measured by the S&P 500 index, is basically a measure of the health of corporations and the level of panic in the investor community. It will tend to exaggerate recent recessions as the stock market has become more volatile.

Let's look at the metrics for the 2008/2009 recession:
GDP Contraction Peak to Trough:
3.9% (through Q2 of 2009)
Rank: 3rd (behind the Great Depression and the post-WWII bust)
Worst Case: 26.6% contraction -- the Great Depression
% of Worst: 14.7%

Peak Unemployement:
9.5% (June 2009)
Rank: 3rd (behind the Great Depression and the 1981-1982 Recession)
Worst Case: Approximately 25% -- the Great Depression
5 of Worst: 38%

Stock Market Decline (S&P 500 Peak to Trough):
57% (March 2009)
Rank: 1st
Worst ever -- worse than the famous stock market crash in 1929.

What you see is a picture of an economy that was very bad, but nowhere close to as bad as the Great Depression (which had almost triple the unemployment and seven times as much economic contraction.) The overreaction of Wall Street is obvious from these statistics -- ownership of companies in the US did not become 57% less valuable in 2008.

What you see now are more reasonable valuations for US companies as the world has realized that the bottom did not, in fact fall out.

So, what do we need to look for going forward?

Two things:
(1) A return to positive GDP growth in Q3 -- my ratings all pre-suppose that the economy is done contracting. There is ample evidence to support this point of view, including a 1.0% annualized contraction rate in Q2, far less than the 5-6% contractions we had seen the prior two quarters. But it is not a sure thing. If the economy continues to contract in Q3, we could be in for a lot more pain.

(2) Unemployment. Jobs, jobs, jobs. That will be how the public perceives any recovery. We are at a historically high level of unemployment still. See the histogram below and you can understand that we are very much at recession-rates of unemployment.

Mean unemployment: 5.6%
Median unemployment: 5.5%
25th Percentile ("Economic Boom"): 4.5%
75th Percentile ("Economic Bust"): 6.6%

As you can see, our current rate of 9.4% is still way outside of the norm. It is almost half again as much as a "normal" rate of 5.5% to 5.6%. It is greater than in 97.5% of the months that have occurred since the start of 1948. Getting unemployment down under that 6.6% threshold is critical...but may not come any time soon. Employment recovery tends to lag GDP recovery as companies are slow to hire back after tough economic times. President Obama would be lucky if it is back down that low by election day 2012, congressional Democrats likely won't be so lucky in 2010.

All-in-all, there is light at the end of the economic tunnel. But that probably doesn't make you feel any better if you are unemployed.

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