THE "R" WORD

The following blog post summarizes recent events in the U.S. economy leading up to a recession and reassures that there is remedy at the end of the tunnel.


THE "R" WORD
By Ron Ojeda

OK, the writing is on the wall. It appears 2008 will be a sluggish year for the overall U.S. economy. Last Friday capped off the worst seven trading day start to the new year since 1990 when Saddam Hussein’s army was still getting settled in Kuwait. Economists across the financial industry have shifted their views on the possibility of a recession past the 50% mark and acknowledged it as the more likely outcome going into 2008. The word “Recession” brings up images of closed businesses and unemployment but let’s clarify the definition of recession.

An economy that is in a recession has experienced at least TWO quarters of contraction by measure of the GDP. That’s correct, two. This is not to say it is not serious, especially to those families and individuals who are directly impacted by it. However, maintaining even a medium-term view, 2 to 3 years, allows all of us to focus on the forest instead of the trees.

The recession is being ushered in by three primary factors. The labor market which, as of last week gave us the first empirical evidence of a recession, two quarters of contraction. The January 3rd employment report for December 2007 showed an *” outright decline in private sector payroll jobs and a substantial increase in the unemployment rate. Since World War II any increase in the three month average of the unemployment rate by more than one third of a percentage point has been associated with recession.”

While this seems significant, the more worrisome factor is the apparent weakening of consumer spending. Two thirds of Gross Domestic Product (GDP) is consumer spending and has been watched carefully over the past four years for signs of weakness. Quarter after quarter, year after year, the American consumer has not disappointed analysts and economists. Despite a negative personal savings rate, a deterioration in real wages and increasing personal debt, the consumer has continued to “go to the well”. In the last several years liquidity has been dysfunctionally provided by the rise in the values of their homes and the financial industry’s willingness to allow them to tap into what has historically been an important savings tool for Americans.

Lastly, business activity, from capital expenditures to new hires, could be soft in 2008. The Institute for Supply Management (ISM) monthly index moved well below 50. Anything below 50 suggests slowing activity in the manufacturing sector.

On the positive side there are several factors which should have dampening effect on the length of any possible recession. The Administration has announced a $70 to $100 billion stimulus package, details to come later this week. The biggest caveat in that plan will be the test of legislator’s discipline to not attach all manner of long-term “pork” expenditures to the needed short-term stimulus package lest those long-term commitments provide an inflationary effect on the economy.

Another positive factor will be increased exports because of the continuing saga of the weakening U.S. dollar. With foreign central banks looking to raise their benchmark rates while the U.S. Central Bank is being compelled to cut rates, that trend will most certainly continue. But this cannot be relied upon as a substitution for the U.S. consumer. Despite our perception of their size, three major trade partners, China, Russia and India have combined Gross Domestic Product of only $4.6 Trillion. According to the U.S. Bureau of Labor Standards, consumer spending accounts for 60% of the $13.2 Trillion U.S. economy or $8 Trillion.

Last but not least is the expected continued cuts in rates by the FED. The fact that they are coming is a foregone conclusion. Yesterday’s Producer Price Index (PPI) showed wholesale prices fell 0.1% after a 3.2% surge in November, Today’s Consumer Price Index (CPI) number should convince the Fed that concerns about inflation should be put on the backburner for now and managing the economy through this rough patch should be the priority.

* January 9th, U.S. Daily Financial Market Commentary (Goldman Sachs)