ETF Trends
ETF Trends

A recent CNNMoney survey of economists pegs the odds of the U.S. entering a recession this year at 18%.  Considering the duality of the current market turmoil caused by Chinese capital flight and the propensity of news-outlets to give time and space to the most outrageous of economic doomsayers, it’s no wonder investors are scared.  Yet, a reasoned analysis of economic data and a detached look at some historically viable indicators renders most of the recessionistas little more than false harbingers.   A recession is defined as two successive quarters of economic contraction as measured by a decline in real Gross Domestic Product (GDP).

Some of the best economic data is free and available at the various Federal Reserve websites.  For example, the New York Federal Reserve regularly publishes the Probability of US Recession Predicted by Treasury Spread.  This indicator, which derives its’ probability by looking at the spread between the 10-Year US Treasury and the 3-Month US Treasury, is currently predicting about a 4.25% likelihood of recession.

The formula for calculating GDP is relatively straight forward, but all changes in GDP aren’t equal.  GDP is the combination of spending on Consumption, Investment, Government, Inventory Adjustments, and Net Trade.  This formula is GDP = C + I + G +IA + (X – M).   Furthermore, all GDP is not created equal.  For example, most economists would agree that naturally occurring spending on Consumption & Investment is a better indicator of economic virility than government spending from temporary fiscal stimulus. Yet both have the same positive impact on GDP.  Similarly, a strong consumer sector can cause imports (M) to increase which subtracts from GDP.  A strong consumer importing goods is no cause for alarm.

GDP QoQ% Growth

To be sure, 2H-2015 GDP growth slowed from 2.3% in 1H-2015 to 1.5%.  It is estimated that Q4 GDP slowed further to 0.8%.   But this is hardly a surprise after a long string of strong quarters and the historically volatile nature of GDP prints.  Despite all this, many are throwing around the recession idea.  Breaking the 2H-2015 into GDP’s components is illuminating and suggests recession fears may be overblown.

Component1H—20152H-2015 (est.)
Consumption1.8%1.7%
Investment0.8%0.7%
Government Spending0.1%0.2%
Inventory Adjustments0.4%-0.8%
Net Trade (Exports – Imports)-0.9%-0.4%

The main drag in the slowdown in 2H-2015 GDP growth is sure to be inventory adjustments.  Adjustments to inventories are largely transitory in nature and should not be assumed to impact GDP numbers on a consistent or regular basis.  And, since the US perpetually runs a trade-deficit the negative contribution to GDP is ubiquitous.  Of positive note, the strength of the waning US dependence on foreign-oil is likely to continue to positively impact GDP.

Other coincident indicators are not flashing ominous signs of a recession either.  US employers continue to add jobs at a pace that is bound to bring inflationary wage pressures.  Personal Income, Real Business Sales, and recovery in the residential real-estate markets continue to remain positive suggesting the US economy will not enter recession this year.

 

Herb Morgan is the Founder, CEO, and Chief Investment Officer at Efficient Market Advisors, a participant in the ETF Strategist Channel