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Recession or not?


A hint of fall is in the air, and so is talk of recession. Yet there's a big difference. Autumn is really here -- replete with cooling temps and college football -- while recession is just a rumor.


Recessions, after all, are among the rarest of economic episodes. They're often expected but rarely emerge. Whenever there's a big hiccup in job growth, retail sales, a credit crunch or a downdraft in the stock market, fears of a broad, long-lived decline in U.S. output accelerate.


Veteran analyst Philippa Dunne reports that this month the number of stories in The Washington Post and The New York Times mentioning "recession" has risen to 4.4 per day, up from less than two a month ago and rising at the highest rate since 1987. Meanwhile, a survey released this week said a majority of U.S. hedge fund managers believe a recession is likely in 2008.


But in fact, the U.S. economy is unbelievably diversified, and it takes problems the size of nine Mack trucks, all working together, to knock it down once it gets going. And even then it's hard to keep the American economy down for very long, as the average length of a recession in the past five decades has been just 11 months, while the average length of an expansion has been six years.


So why does it feel like the recession call is so right this time, and what can you do about it if you're absolutely sure it's coming? These are matters for debate by the best analytical minds in the world, not your gut.


Last week, I provided the apocalyptic view of Satyajit Das, a credit-derivatives expert in Australia who believes Western economies will crash over the next five years as the pillars of debt on which they are built crumble. Fair enough -- could very well happen. Today, we'll hear a counterargument from Lakshman Achuthan, one of the few economists in the world who can legitimately claim to getting the last two recession calls right. And we'll also tune in for a moment to Nouriel Roubini, a business professor at New York University whose vision for the next few years makes total darkness look sunny.


And then I'll tell you what to do with your portfolio, based on the disparate forecasts of these experts.


Clear signals
Let's start with Achuthan, the managing director of the Economic Cycles Research Institute and a longtime source of reality-based opinion -- not guesses stacked atop assumptions. Achuthan points out that recessions are characterized by two clear phenomena: Millions of people lose their jobs, and the Federal Reserve cuts interest rates in bunches. Starting in 1989, the Fed cut rates 21 times totaling 6.75 percentage points to ward off the 1990-91 recession. In 2001, the Fed started a series of 13 cuts, lowering rates by 5.5 percentage points.


When the economy is merely slowing, Achuthan notes, the Fed cuts sharply but infrequently, primarily to provide shock treatment rather than real monetary stimulus, such as the three rate cuts in fall 1998 around the collapse of the hedge fund Long-Term Capital Management.


Since job losses are by no means rampant, and the Fed has cut the federal funds rate only once so far, ipso facto, there's no recession. So why do so many people feel like it's here or imminent? Achuthan says it's because the economy is suffering from a large set of seemingly bad events -- but that it's a mistake to just add them up and say they will push the nation into calamity.


We've had a long series of Federal Reserve rate increases, a housing recession, an oil shock, an inverted bond-yield curve, a credit crisis and a single month of job losses in August, and stocks fell 8% in the summer. But because the long-term economic cycle is still mostly on upswing, the U.S. is for now immune to the impact of even these direct hits.


Achuthan bases his forecast for no recession over the next quarter or two on his organization's Weekly Leading Index, which accurately forecast the 1990-91 and 2001 recessions, and none in between or since. It's a composite of several indicators that have been proved to lead the economy, and thus it looks around corners in ways that strictly linear economic forecasts do not. While he warns the data could certainly suffer an exogenous shock that would move up the date of a potential recession to the first half of next year, here's how the data set currently shapes up:


Investor confidence -- mixed. This factor is a composite of equity-, bond- and commodity-market players' level of optimism, which drives prices. Currently, equity markets are stabile, commodities are rising, and bonds are flat. The ECRI commodity index, by the way, doesn't just measure speculative items like crude oil and gold but includes industrial materials for which there are no futures market, such as tallow, rubber and burlap. When their prices are rising, industry shows confidence that they will need more raw materials for future manufacturing -- the opposite of what they'd do if they believed a recession were coming.


Monetary stimulus -- positive. The Fed Reserve has reversed its prior stance of neutrality and is aggressively printing money and pouring it into the economy. The recent rate cut turned this factor around. 'Nuff said.


Housing -- negative but stabilizing. Home prices are still falling but not as steeply as earlier in the year. This will probably remain negative for a year or more as foreclosures put more homes on the market, depressing prices.


Jobs -- mildly positive. In August, a report of a jobs setback stunned the market, but the data were actually not terrible. Manufacturers weren't hiring as much as they had been, but they weren't firing people, either. Bar and restaurant hiring was actually up, showing that these service operators believed customers were still coming. Jobless-claims numbers were light and definitely positive. In sum, there have been no clear-cut stats forecasting massive layoffs.


Corporate profit growth -- positive. Corporate earnings are the most important driver of the economic cycle, and they appear to be holding up despite tough comparisons. Last year we saw double-digit growth, and this year it's in the high single digits. "Without a recessionary plunge in profits, it's hard to have a recession," Achuthan says.


He reports that the Weekly Leading Index growth has been softening, though not in a pervasive, profound way. It forecasts the potential for a slowdown to below-trend growth of about 1% to 2.5% over the next six months, but not a three-alarm fire. As long as creditworthy individuals and companies can still get loans, showing that debt markets are functioning normally without the extreme levels of distrust shown in August, then the economy can muddle through at least through the second quarter.


After that, a lot of homeowners' adjustable-rate mortgages will reset higher, and asset-based corporate commercial paper must be rolled over, and the Weekly Leading Index's forecast may change. Achuthan promises to keep us posted....


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