Middle East Economic Survey
VOL. LII
No 20
GENERAL
The Crocuses Of Bottoming Out In The US Recession
By Shawkat Hammoudeh
Dr Hammoudeh is Professor of Economics and International Business at Drexel University. He can be reached at hammousm@drexel.edu.
They say crocuses are the early signs of spring. They bloom before the daffodils, tulips and certainly roses do, and while the weather is still cold. When such a metaphor is applied to the US economy, some people are now referring to what I call economic crocuses as the ‘green shoots’ or ‘mustard seeds’ of the economic recovery. Admittedly, when I wrote a first version of this post in March,1 I said that it was premature to talk about an early recovery in the US economy, but now in May the situation has strengthened and reinforced the theme of the first version, pointing to a faster than expected modest recovery in the coming months. I believe now that there are stronger early economic signs which signal that the US recession has bottomed out.
Figuratively speaking, we are now on the horizontal bar of this L-shaped recession, where the bar may have a total lifespan of about seven months counting from March 2009. I do not see the downturn as a W-recession, because the early signs of stabilization have strengthened over March, April and part of May. In fact, we are possibly about one-third along the horizontal bar segment of the L-shape. How much will that take in calendar time to complete the remaining two-thirds, be off the horizontal bar and turn the L-shape into a U-shape? Most likely, this will likely happen in the next five months. I believe that the worst is behind us and a feeble recovery should start in the fourth quarter of 2009 and a modest growth in 2010.
Hope From Economic Indicators
There are signs of glimmering hope coming from both leading and coincident economic indicators suggesting that the light is near the end of this year. Interest rates move up when the economy improves. There have been rises in the US Treasury bill and bond rates. On 28 November 2008, the three-month bill rate dropped to 0.01%, signaling that the economy was in a liquidity trap and the recovery was a long way off. This rate rose to 0.19% on 7 May 2009. The 30-year Treasury bond rate bottomed out at 2.53% 18 December 2008, but it rose to about 4.2% on 7 May 2009. These numbers suggest that the yield curve between the T-bill rates and bond rates is steepening, which is generally a sign that the economy is improving and deflation is waning. Concurrently, the TED spread, which is the difference between rates banks charge each other for very short term loans (Libor) and short term T-bills rates, is now 77.5 basis points, down from a peak of 464 basis points during the height of the crisis in October 2008. This suggests that the banks now have a lot more confidence in each other than they used to six months ago. The US government’s recent ‘stress test’ confirmed that by showing the big banks don’t need as much capital as was thought.
There is also an increase in the junk bond yield. Junk bonds include distressed bonds of companies in different sectors of the economy that are near restructuring or already are being restructured. Such junk bond issuers account for 17% of the S&P 500 and nearly half the corporate bond market.2 The direction of change in the junk yield is a signal of change in confidence in the troubled sectors of the economy such as autos and financials. The average yield was about 20% last summer, and then it dropped precipitously to 9% in December 2008 at the height of the recession, after heavy selling by hedge funds who were forced to sell in the face of redemptions. It is now above 13%. While it is modest, it represents increased confidence in distressed companies like autos.
In the stock markets, the US and other countries have witnessed significant gains since the lows at the end of 2008. By the first week of May 2009, the S&P 500 has risen significantly since its low near the end of 2008. It is now in positive territory for 2009. The MSCI-Emerging Markets index has increased by more than the S&P 500. Brazil’s Bovesta index climbed up by 80% and Korea’s KOSPI was up by 70% since November 2008. It is known that the stock market is a leading indicator, because it is forward looking and it starts to rise before the real economy as represented by GDP does. In the last 60 years, the US stock market rose five months on average before the GDP did.
The gains in the US stock markets have recently blown optimism into US consumers. Gallup’s Consumer Mood Index leaped 6 points for the week ending 5 April, the fourth consecutive weekly increase. This index is now as high as it has been in more than a year. Moreover, the number of Americans who think the US is moving in the right direction has more than doubled between October 2008 and February 2009, reaching 40% of those surveyed. The Conference Board’s consumer confidence rose 12 points in April, after a small increase in March. This index gauges consumer plans and future spending in the US and the consumer represents 70% of the economy. The index level gave a reading that surpassed most economists’ expectations and is the highest since 2008, when the financial crisis started to intensify. What’s important about this consumer confidence survey is that it showed substantial improvement in the consumers’ expectations over the next six months, particularly their job outlook. This short run expectation index suggests that the economy is searching for a bottom.
The orders for durable goods index, which is a leading indicator, was at its highest in February 2009 since August 2008. However, this index dropped slightly in March, which is the seventh drop in eight consecutive months. It is known that this index is very volatile and we need a three-month rising trend for this index to portend an improvement in the manufacturing sector. This sector will be a contributing cause to having a feeble recovery in the fourth quarter of 2009.
Mixed Signals From Labor Markets
The labor markets include leading, coincident and lagging economic indicators. The data for new claims of jobless benefits, which is a leading indicator, showed that the number of newly laid off workers applying for benefits decreased to the first week of May, which is better than economists expected. It represents a drop of 5.35% from its peak a month ago. This on its own can be considered a significant decline in new claims, which historically signals the end of recession. It is probably too hasty to make such a judgment now in the middle of bottoming out, but it is still a significant positive signal. On the other hand, the average work week, which is also a labor market leading economic indicator, has shown a slight decline in the average work week for March 2009, suggesting that the labor market will continue to be a drag on the economy. Since March 2008, the average weekly hours worked by manufacturing workers has declined by 4.6% and is still showing declines. The average work week fell from 39.5 to 39.3 hours on a seasonally adjusted basis during February and March of 2009. The total number of hours worked in the private sector also dropped in March to 33.2 hours (a new record low), after not showing declines in three consecutive months. This drop signals that there is still some slack in the labor markets that has yet to work its way through the system. The number of non-farm payrolls (NFP), which is a coincident indicator, suggests that the job loss is moderating. Since the recession started in December 2007, about 5.5mn jobs have been lost, with almost two-thirds of the loss happening in the last six months. In April 2009, the job losses were about 530,000 jobs; still they are significantly less than the losses in March and the lowest in six months. But this is a coincident and not a leading indicator, and it usually improves when the real economy improves. The unemployment rate is a lagging indicator and could continue to blink red for more than a year after the economy recovers, which I predicted to happen in the fourth quarter of 2009. This should not be a surprise to anyone even if this rate rises to 10% into 2010, from the April level of 8.9%.The labor market will contribute to be a cause of having a feeble recovery in the fourth quarter in 2009 and a modest one in 2010.
Most of the serious problems are in the housing sector, which is at the heart of the current recession. There is an inventory overhang that is still rising, amounting to more than 4mn units or more than nine months of supply. The inventory will rise as people are possibly waiting for housing prices to rise before they put their homes on the market. However, there are glimmering signs of an improvement in the housing sector in the US. The housing affordability index, on the other hand, has risen on a yearly basis by more than 10%. In February, mortgage applications increased by 32%, existing house sales by more than 5% and new housing sales by more than 4%. Still, the housing market along with the labor market will be a damper well into 2010, but both markets should not stop an overall recovery beginning to occur in the fourth quarter. We could still have a continuing sector recession, while the overall economy is recovering.
Pasta And Cardboard Indicators
As the recovery hopefully starts, the ordinary citizen can feel improvement in some special coincident indicators she or he is familiar with. These include sales of pasta, cardboard and gloss sales, among others. Pasta is cheap and people buy more of it in bad times.3 In 2008, its sales increased by 22% after years of very weak growth. While part of the increase is due to the hike in commodity prices, the huge increase implies that pasta is taking a larger share of the average family’s grocery basket. When this countercyclical food measure indicates trouble, it signals that better times are ahead. Liner board is the major component of cardboard, which is used as packaging to ship almost every thing that can be shipped.4 When liner board prices start to move up, it means demand for many goods is picking up. When this pro-cyclical cardboard coincident indicator flashes green, it also means that better times are around the corner. It is hard to detect the liner board prices, but stock prices of cardboard companies can be a proxy. According to Leonard Lauder of Estee Lauder, gloss sales are a counter indicator. It is an inexpensive indulgence during recessions. Women can use it several times a day in bad times to refresh instead of buying new clothes.
The Baltic Exchanges’ Baltic Dry Index (BDI), which measures the cost of shipping dry raw materials (iron, copper, dry grains etc), is also considered a leading economic indicator. In December 2008, it reached a 22-year low. Since then it has bounced about 175%. This rebound indicates that shipping costs have turned the corner after reaching their bottom. However, this index has not been a reliable leading indicator lately, as it has given false signals twice in 2007 and 2008 because it is influenced by commodity demand from China. The BDI has risen almost 200% to a current level of 1,900 in February after hitting a peak of around 12,000 in 2008.
Let us hope that the momentum will continue and the economy prolongs its improvement. Let us hope that we will not experience any unexpected shocks from events such as the swine flu. The next five months should bring more strengthening in most leading economic indicators, and thus more coincident indicators such as personal income, retail sales, construction spending and GDP will follow suit. But we still have to wait longer for the labor market to improve.
Notes:
1. http://blogs.zawya.com/shawkat.hammoudeh/090404174033/
2. http://tinyurl.com/5a9psu
3. http://www.time.com/time/specials/packages/article/0,28804,1876737_1876735_1876711,00.htm – “How to Know When the Economy is Turning Up: 7 – The Pasta Indicator.”
4. http://www.time.com/time/specials/packages/article/0,28804,1876737_1876735_1876712,00.html –“How to Know When the Economy is Turning Up: 8 – The Cardboard Indicator.”