Posts Tagged ‘recession’
Predicting recessions
The onset of a recession is much like the onset of a bad cold, or perhaps the flu. You THINK you know you have it, and then the next morning you wake up feeling like you’ve been hit by a truck.
What if we had a tool that could actually PREDICT a recession a year or so in the future? Wouldn’t that be handy? In fact, two researchers at the New York Federal Reserve Bank actually developed something a few years ago (early 2006, to be precise) that seems to have some promise. They noted that the spread between 10-year Treasuries and 3-month Treasuries was a leading indicators of economic activity (which makes intuitive sense). Using historical data, they craft a formula which calculates the probability of a recession occurring in the coming 12 months:
…where “spread” is the difference, in percentage points, between the 10-year yield and the 3-month yield and F is the standard normal distribution (mean of 0, standard deviation of 1). Plotting their data over time, and comparing to the onset of a recession, they get Chart 2. While no model is 100% predictive, this one clearly indicates that a recession is highly probable whenever the spread-indicated probability gets much above 30%.
Of course, the statistical math can get a bit hairy, but there is a handy rule-of-thumb. As you can see from Chart 1, whenever the spread turns negative, a recession is fairly likely in the coming months. Why? Because a negative spread suggests two things: first, that borrowers have little demand for long-term money, and second that investors are looking for a safe place to tuck money away that they don’t think they’ll need for a while, and aren’t afraid of inflation. In short, the yield spread constitutes a fairly accurate survey of investor expectations about the economy.
Unfortunately, Estrella and Trubin end their research with July, 2006, which at the time was giving off a 27% recession signal for July, 2007. A great test of their model would be to see if it would have predicted the onset of the December, 2007, through March, 2009, recession. We used the same H.15 data from the Federal Reserve Board, and came up with the following:
Ironically, our analysis shows that the probability of a recession crossed the 30% barrier on July 31, 2006 — a month after the cut-off of their study, and 16 months before the official “onset” of the recession.
By the way, if you’re worried, the current probability is at 1.8%. We’ll keep you posted.
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Conerly Consulting
Dr. Bill Conerly of Portland, Oregon, produces a wonderful little economic report called the Businenomics Newsletter. You can check it out here. While it is heavily Pacific Northwest focused, he has some great insights into the “big picture” of the U.S. economy as a whole. I highly recommend his research, and (as long as I’m in the promotion game), he’s a great public speaker.
He discusses two key elements of the “end of the recession” right up front — the current consensus forecasts of strong GDP growth for the next two years and the current “bounce-back” in consumer spending (which fell off significantly from mid-08 to mid-09). Unfortunately, capital goods orders are only sluggishly recovering, and state-and-local budget gaps continue to be a drag on the economy.
As for construction, the decline is over, but the bounce-back is sluggish. Residential construction fell from an annual rate of about $550 Billion in the 2007 range to about $250B in 2009, and continues to flat-line there. Private non-residential peaked at about $400B in 2008/09, and has since declined to about $250B (where it’s been hovering for since early 2010). Public non-residential has been on a bit of an up-swing all through the recession, but is still barely above 2007 levels (about $300B). In short, these three sectors taken together have more-or-less flat-lined for the past year and a half or so, and appear to be staying there for the time being.
Anyone who reads the paper or watches the news on TV knows we’re in the midst of a raw materials crisis, with aggregate materials prices (the “crude materials index) up about 25% from its recent mid-2009 low. However, the price index is still well-below early 2008. Conerly suggests that the rise is “hard on some, but will not trigger general inflation.”
The money supply (M-2) continues to grow, and QE2 has apparently not had an inflationary impact, at least from reading the charts. Indeed, prior to QE2, the money supply chart looked like it was ready to flat-line. In total, as Conerly notes, the stock market appears to be happy that the economy is growing again.
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Post Thanksgiving, time to go back to work…
In past years (say, pre-2008), the Thanksgiving thru New Years period at Greenfield was always slow, as clients and projects seemed to hunker down for the holiday season. Naturally, 2008 was an aberration on a number of levels — the real estate let-down was in full force, and while our business flow was down, we were busy “hunkering down” for what we projected would be a long recession trough.
Last year (2009) was unpredictable. The first half of the year was dreary, but the last half was a rebuilding period for us, as has been 2010. We’re not yet where we want to be (that is to say, back on our pre-recession growth curve), but the accumulations of lessons-learned have put us in a great position for the future.
I’m commenting on our specific experience at Greenfield for a reason. I think our own company experiences are emblematic of what is happening at tens of thousands of other businesses across the U.S. and other countries, and has significant implications for the future of real estate, the economy, and finance for the next few years. I’m always reluctant to get into the prediction business (I’ll leave that up to Faith Popcorn and her ilk), but I can make a few generalizations, particularly as the parallel what I saw back in the 1970’s —
1. Business profits (and valuations — as we see from the stock market) are headed upward, not so much from increased sales (flat across the board) but also thru extraordinarily increased efficiency. One might wonder, if firms are so doggone efficient today, why weren’t they acting efficiently a few years ago? Simply put, “efficient” firms don’t grow very well. Growth usually requires a significant degree of wastage. Hewlett Packard was famous for this — they would budget engineers a certain amount of time and support to just tinker with things, knowing that the sort of Edison-esque profitability that came out of such tinkering. At one time, Xerox was so inventive that they thru away lots of great ideas, the Graphical User Interface being the best known example. Additionally, efficient firms cut wa-a-a-a-a-y back on hiring, training, and marketing. We see this now on college campuses, as new graduates (even in the “vocational” schools like business and engineering) are getting no offers or offers far beneath what their big brothers and big sisters got a few years ago.
2. This “hunkering down” not only cuts the demand for commercial real estate, but also means we may have a substantial excess supply of offices, warehouses, and shopping centers for some time to come. Ironically, business travel is coming back (as executives work harder to sell the same amount as before) but everyone is going “down” a notch on the hotel food chain — executives who used to stay at a Ritz Carleton are now at Marriotts, and former Marriott customers are now at Courtyard Marriotts. (Intriguingly, the Marriott organization is highly vertically integrated, and so actually takes great advantage of this phenomenon). The interesting off-shoot is that while aggregate hotel room counts are up, hotel employment lags (as customers move from “full-service” to “limited service” stays). The same is true with hotel restaurants, as dining-out budgets get slashed.
3. The “trainee” employment picture is worsening in some ways, but may actually improve in others. As noted, new graduates are having real problems getting placed, and are having to accept entry-level jobs far below expectations. I spoke with a young woman recently who graduated in 2010 in Finance. She had great grades and a stellar resume, and fully expected to get an entry-level job commensurate with her expectations. Guess what? No one is hiring. After several frustrating months, she accepted a job as a teller at a Credit Union at about half the starting salary she’d previously expected. Is there a silver lining in this? Yes, two. From the business’ perspective, they’re getting entry-level talent at bargain basement prices, and if they’re willing to mentor and foster these kids, they’ve got talent who will have a much greater familiarity with the nuts-and-bolts of the business once expansion does return. From the “hiree’s” perspective, a foot in the door builds experience and puts her at the starting gate ahead of the rest of the pack.
4. The early 1980’s recession was actually the last of a series dating back to the late 1960’s (the period was called “stag-flation”). While the early-80’s recession was the worst of the bunch, it seemed to have wrung the last of the “bad stuff” out of the economy, and set the stage for two decades of nearly continuous growth. Many credit the pro-business agenda of the Reagan Administration, but that ignores the tremendous pent-up inventiveness which had been waiting for an opportunity. Gates, Allen, Jobs, and Wozniak had been tinkering with computers and software for a decade, but needed a business expansion to really get themselves going. Sam Walton had great ideas about merchandising, but the explosive growth of WalMart depended in no small part on the availability of cheap construction and development credit to build mega-stores at seemingly every street corner. We decry the sloppiness of the mortgage market of the past few years, but no one seems to complain about the millions of construction workers and realtors who rode from apprenticeship to retirement on the wave of the housing boom. Recessions do not last forever, although this one does have the symptoms of lasting for a while longer. When 4% GDP growth returns (and remember, folks, that’s really all it takes), we should be poised for a period of expansion not-unlike the one that started in the mid-1980’s.
Well, folks, that’s really it. Like most of you, I have a lot to be thankful for. I live in a fairly free country, with an economy that considers 9% unemployment and 2% GDP growth to be unacceptable. I get the opportunity to interface with students and young folks on a daily basis, and they constantly refresh my positive outlook for the future.
From a small northwestern observatory... 