The Three Ds and How to Put an Outlaw Recession to Work for You

 

By Lynn Carpenter

Dear Reader,

Depth, diffusion, and duration.  That’s how we measure recession now.  And we may be in trouble. There’s still inflation, I contend, but the Ds are piling up.

You probably know that a recession is two consecutive quarters of declining GDP.  That’s what we all learned in school, and many people still think it’s the yardstick.

But that’s the 1950s model.  It’s not rounded enough.  GDP could decline because of falling exports, while employment, productivity, and other measures stay aloft.  All it would take is enough stateside demand to absorb the drop in exports.  Why does this matter?

Because recessions in the last 20 years have been outlaws compared to the old-style recessions.  They have a long, slow recovery pattern in jobs that could be bad news not only for those who already lost theirs, but also for all those students about to graduate high school and college expecting to go to work.

Look at this chart (source: Economic Policy Institute).  After a recession ends these days, we are apt to have what became known as a “jobless recovery” in the 1990s.

That’s rotten for working people.  And true to the often-uncomfortable truth about investing, what’s bad for people may be good for stocks.

For you as an investor - and I hope you are not out of work unless it’s by choice - the year after a recession ends may be extra sweet because companies begin to increase sales and production without increasing payroll costs.  Their earnings rise with added vigor during this period.

For the first year after the “official” end of the recession, the stock market may be calm to moderately positive.  At this point, people aren’t sure it’s over, though stock value is building strongly underground.  Doubt still rules price a bit, especially if jobs are still down.  Then within the next six month to a year, the market takes off.  Don’t focus too much on the timing here.  The key is the psychological turn.

And this is why you might want to know more about the three Ds.  So you don’t look at the wrong metric (jobs) and miss the timing.

We all learned the two-quarters-of-falling-GDP rule.  Half the reporters still cite it.  But the office that dates recession - the National Bureau of Economic Research (NBER) - abandoned that method years ago.

Now they use depth, duration, and diffusion.  And with the latest jobs report, we just got diffusion.

The jobs loss is large and wide, affecting multiple industries instead of being concentrated in aeronautics factories, steel mills, or other niches as often happened in recessions of the last century.  

The BLS says we lost 63,000 jobs last month.  That’s on top of the 23,000 jobs that we lost in January, according to the ADP employment report.

That’s startling.  But here’s something else you will want to know: job losses seem to be a lagging indicator.  Jobs get cut when there is nothing else left to cut.  By the time the losses show up in the reports, the recession has already been running.  The bad news actually means the end is closer rather than farther away.  Of course it doesn’t seem like that to anyone out of work, that’s for sure.

So if you are thinking about that year after the year after a recession ends, it might not be two years away.  You can’t tell by looking at jobs.

And you also can’t tell much about a modern recession by looking at GDP.  I’ll finish off with a couple of nice pictures that will do you more good than another thousand words.  These are from James D. Hamilton, Professor of Economics at the University of California, San Diego, and Menzie Chinn, Professor of Public Affairs and Economics at the University of Wisconsin, Madison.  They’re a little dated, but we’re looking at history and they’re nice charts for showing how multiple recession benchmarks come together.  Or not.

In these charts, the gray bar is the 2001 recession.  In the first chart, see how the GDP fell only slightly in 2001.  What was so bad about that? Bumps are normal.

But then look at the next chart.  The red line shows employment.  The blue line is industrial production.  You can see that these losses were a lot steeper than the GDP change showed.  What’s more, you can see that employment losses came much later than industrial output slowed.

As recessions go, GDP losses were mild in 2001

What does this mean to you, assuming you have a job if you want one?

The three Ds - depth, duration and diffusion - all need watching.  That’s why the latest employment report is serious, and unless there’s a sharp rebound in the next one, the diffusion D seems to be fulfilled.  

The duration D still has a ways to go.  

And the depth D is still moderate, since the amount GDP has fallen is not much yet.  But it wasn’t in 2001, either.

Are we in a recession?  NBER hasn’t decided yet.  But take a tip from the payrolls and act as if we are.

Now if only we knew the end, we could load up for the recovery right on time.  But pay more attention to reports on industrial production than to employment figures if you want a heads up on when to anticipate recovery.

Respectfully,

Lynn Carpenter