Evaluating the Recession Clock

I'm setting the recession clock to 2 minutes to midnight.

Most economists now agree that we've come out of the recession. US GDP increased at an annual rate of 3.5% in Q3 (although that is a preliminary number). But it's important to examine why the economy grew. In Q3, we are seeing the combined effects of a large number of federal stimulus packages, continuing record low interest rates, expectations of record high government spending in the future, and the Cash for Clunkers program. While government spending can help push an economy up temporarily, consumers need to spend to sustain that level in a more lasting way. We will see whether the US consumer can make up the difference in Q4.

Let's break down the Components of GDP (Demand Side):

Consumption:

Things had been looking up for consumption, but remember that this number was heavily influenced by the Cash for Clunkers program. Now that the program has ended we'll start to get some more accurate readings on consumer spending. Here is the graph for consumption spending (measured by PCE):

Investment:

Business investment is down and still falling. While it is unsurprising since businesses rarely invest heavily during recession times, it is discouraging given the historically low interest rates. Also, Business investment should be one of the first indicators to tip up after a recession. If consumer spending projections increases, businesses will try to capitalize on the still low interest rates. Business's reluctance to invest could be a indication that they expect lackluster sales for an extended period of time.

Businesses may also be holding off investing because they don't foresee interest rates rising in the future—ergo, they can prolong a decision until they have better information and suffer no ill side effects. Consider the irony, the Fed's insistence that it will hold to an expansionary policy for "an extended period" is encouraging companies to procrastinate investing.

Here is the graph for Business Investment:

Residential Investment reports on the other hand are actually positive. It could just be a one month anomaly. It could be that housing has finally hit a bottom. In Q3 real residential fixed investment increased 23.4%. If this trend continues, it could provide the foundation for a strong recovery. Income and spending theories tell us that as home values increase, consumer spending increases. That being said, it is way too early to tell if this is will happen. We'll keep our eyes on it. Here's the graph:

I'm going to skip over Government Spending. In short, they're spending a ton of money and they've promised to spend even more. That being said, at this point in the economy, whether we fall back into a recession or move on to a recovery and expansion will have little to do with government spending and everything to do with the other components.

Net Exports:

After a rally in November 2008 and again in February-March 2009, the dollar's value has fallen consistently. Consider the chart:

With the devaluation of the dollar, theory would tell you that exports would increase and imports would decrease. Net exports has increased, but it's in spite of exports, not because of it. Again consider the graph:

The increase in Net Exports is more a reflection of the US consumer's reluctance to spend than anything. Despite the positive impact this has on the GDP readings, I consider this very bad news.

Overall, I think we're at a tipping point. If home prices continue rising it will help, but that will take months to have any significant effect. If the consumers can pickup and start spending and businesses start investing, we could start to see the light at the end of the tunnel. However, the shaky employment picture is discouraging spending, and the promise of low interest rates tomorrow is discouraging lending. I put the risk at falling back into recession at very high.