FYI | Nov 14 2007
By Chris Shaw
To date economic data support the consensus view the US economy is slowing but there is little to indicate the economy will slow enough to slide into recession. According to John Hussman of Hussman Funds the consensus view is wrong, as the risk of a recession has actually moved from possible to probable in recent weeks.
Hussman bases his analysis on a combination of economic indicators, as in his view much of the economic data on their own offer little insight into the health of the US economy but together a more accurate assessment can be made. History backs up his approach, as Hussman has to date found no false recession signals taking data back to the 1960s.
His four indicator rule-of-thumb for impending recession is based on a widening in credit spreads, a moderate or flat yield curve, falling stock prices and a weak ISM Purchasing Manufacturers Index, and as a group they are providing evidence of a deteriorating economy and rising credits risks.
While these indicators generate a leading signal Hussman points out confirmation can be obtained from lagging indicators such as a sudden widening in the consumer confidence spread, low or negative real interest rates, falling factory capacity utilisation and a slowing in the rate of growth in employment or hours worked, all of which are trending in the direction of a weakening in the economy.
While the market took as good news last week’s improvement in the trade deficit Hussman sees it as another strike against the health of the economy overall, as an improvement in trade is generally matched by a deterioration in gross domestic investment and this implies weaker capital spending ahead. He expects the US housing sector will bear the brunt of this reduction in investment.
As a general conclusion Hussman points out a recession occurs not as a result of a decline in the willingness of consumers to actually consume but due to a mismatch between the mix of goods and services demanded in the economy and what is being offered, and this is exactly what is occurring in the US at present.
For those taking confidence in the actions of the Federal Reserve (Fed) in cutting rates and increasing liquidity to counter the credit crunch that was precipitated by the downturn in the housing market, Hussman suggests such confidence is misguided as the Fed has actually not injected any liquidity into the system in recent months.
Rather, the central bankers have simply re-injected paper into the market as it matures, as the banking system does not have a liquidity crisis as the issue is one of solvency thanks to mounting loan losses, bad mortgages and the collapse in value of securitised debt and here the Fed can do little to help.
