Thoughts on the NBER's identification of a current recession

The National Bureau of Economic Research declared last week that the US has been in a recession since December 2007.

Real GDP is the broadest measure of economic activity, but the GDP is not measured on a monthly basis, and the NBER has clearly based their dating of a recession on employment numbers. The graph above from the Bureau of Labor Statistics clearly shows unemployment rising beginning in December of last year.

The NBER looks at employment levels, industrial production indicators, manufacturing trade sales, and personal incomes. Out of these four, employment levels are the broadest monthly indicator (the least restricted to a specific sector of the economy or the population) and the NBER gives them the most consideration in its determinations. For example, in the official NBER release last week declaring the beginning of a recession, the third paragraph states that "The committee believes that domestic production and employment are the primary conceptual measures of economic activity" and the following paragraph tells us "This series reached a peak in December 2007 and has declined every month since then."

However, the GDP data for the first and second quarters of 2008 showed expansion, including a 2.8% expansion in the second quarter. The NBER release cited above notes this GDP growth during 2008 (without citing the actual strong numeric growth rates) but then concludes that because the GDP went down in the fourth quarter of 2007 before going up the first two quarters of 2008 and then down again in the third, "the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity."

Our own view of the matter is that the implosion of the financial sector in September of this year caused a nationwide panic that included a near shut-down of activity from the end of September through November, and that it was this extraordinary freezing of business activity that led to the temporary contraction of GDP. Since then, consumer spending in the first part of the holiday shopping season have suggested that the extraordinary panic of those months may be unlocking.

We do not believe that this recession follows the pattern of previous recessions, in which companies have been over-optimistic, built up their inventories, hired too many people, and then were caught flat-footed when the economy suddenly slowed. This pattern did take place in the housing sector, and to a degree in the parts of the financial sector linked to housing, but not in the rest of the economy.

As we have written before, the final spectacular collapse that ultimately created the shock that brought down the rest of the economy was preventable and could have been avoided by the removal of two regulatory and accounting mistakes -- the mark-to-market accounting requirements of FASB 157, and the ability to short stock on a down-tick (which reversed a rule that had been in place since Joseph P. Kennedy implemented it as the head of the SEC in 1938).

Finally, the most important point we would make during this current cycle is the same point we have made repeatedly on The Taylor Frigon Advisor: the importance of owning well-run, growing businesses through multiple economic cycles. Historically, solid businesses end up surviving.

The flip side of this most important conviction is the conviction that those people who tell you they are able to predict the next cycle are selling a very dangerous delusion. There are figures appearing on the financial media and the internet right now receiving all kinds of credit and accolades for "predicting" this all along. The implication is that you should follow the advice of those who are able to call bear markets or recessions before they happen, and benefit from their special ability to predict cycles.

Nothing could be more dangerous. This kind of thinking is a perfect example of the "persistent delusion" that Professor Henry Dunn spoke of in 1939. In that address in 1939, Professor Dunn noted that such "systems may at times have appeared to work fairly well for periods just long enough to mislead the unwary."

For later posts dealing with this same topic, see also:

• "It's a panic, not a Great Depression" 01/21/2009.

• "Managing Investments in the New Era" 02/18/2009.

• "Big news on mark-to-market accounting" 03/13/2009.

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