The recent stock market crash — and the concurrent collapse of bond yields -- has many people believing the U.S. economy is headed toward a recession. The capital markets seem to be pricing in a dramatic slowdown from the current sluggish pace of growth.
But amid the volatility, it's worth noting two significant points. First, the markets are not the economy, and the economy is not the markets. Second, while things can change quickly, many of the most significant lagging, coincident and leading indicators are not flashing recession.
The stock market, which is an efficient long-term processor of data and opinion, is high-strung and highly irrational in the short term, prone to panics and flash crashes. And so as a pure indicator of future short-term economic gloom, the stock market produces a lot of false positives. Just as the 99.5 percent updraft from March 2009 through this spring didn't signify a huge macro snapback, a 15 percent decline doesn't necessarily signify an imminent macro downfall.
Research from strategist Thomas Lee at J.P. Morgan Chase indicates (hat-tip to Sudeep Reddy of the Wall Street Journal) since 1939 stocks have fallen more than 15 percent over four months 30 times. Seven of these painful declines took place after a recession had started, six took place at the beginning of a recession, two took place within 12 months of the onset of a recession, and 15 took place outside of a recession. As J.P. Morgan himself said when asked about the stock market, "It will fluctuate."
Recessions, generally defined as a broad-based fall in economic activity — employment, output, sales, economic activity — are visible only in hindsight. The National Bureau of Economic Research, the official arbiter of business cycles, waits months -- and sometimes years -- after the fact to announce economic peaks and troughs. Here's the NBER's recession dating page.
As we speak, many of the most relevant coincident and lagging indicators continue to indicate growth — sluggish, unsatisfying growth, but growth nonetheless. The economy added 117,000 payroll jobs in July. The fact that payroll jobs are rising does not, in and of itself, mean the economy is expanding. Employment is famously a lagging indicator. But it doesn't lag by much. You can go to the BLS website and construct a chart of payroll figures over the past 30 years and then compare them with the NBER data on recessions. In the past five recessions, payroll jobs peak right around the beginning. The last recession started in December 2007 and payroll jobs peaked in January 2008. The upshot: It's possible to have payroll jobs growth in a recession, but only for a month or two. Conversely, if payroll jobs fall for a few months in a row, it's almost always a portent of contraction. The Conference Board's Employment Trends Index has been falling, but it is "signaling employment growth of less than 100,000 per month through the end of 2011." These employment numbers are blah, even bad. But they're not consistent with economic contraction — yet.
Business activity in the U.S. is divided between the (comparatively small) manufacturing sector and the (much larger) services sector. Each month, the Institute for Supply Management issues surveys of purchasing managers that offer a relatively crude measure of whether manufacturing and services are expanding or contracting. A reading above 50 means expansion, while a reading below 50 means contraction. The most recent surveys signal that both were expanding in July. Manufacturing, at 50.9, was flashing a clear warning sign of slowing, and the new orders index was in negative territory. The more significant services measure checked in at 52.7, signaling a slower pace of expansion than in June. But it showed the sector that drives the U.S. economy was still comfortably in expansion mode. August readings should arrive on September 1.
How about consumer activity? The Census Bureau reports official national retail sales, but we won't get the July reading until next week. In early August, we did receive two private-sector readings on consumer spending. The International Council of Shopping Centers' same-store sales index was up 4.6 percent in July from the year before. (Good!) However, the volatile weekly index has been in negative territory for the past two weeks. (Bad!) The Thomson Reuters same-store sales index for 25 chains was up 4.4 percent in July from the year before.
Throw in car sales and continuing declines in signals of financial stress — lower rates of credit card delinquency, for example — and a picture emerges. As spring turned to summer, the economy was expanding but tentative in the face of Washington brinksmanship and global market tremors, while continuing to grapple with a horrific labor market and a poor housing market.
Indeed, that's essentially the story told by the Conference Board's Leading Economic Indicators Index, which forecasts economic activity three to six months ahead. In late July, we got the June reading, which showed decent increases in May and June, after a decline in April. Generally speaking, the U.S. economy does not go into recession unless and until there is a pronounced downturn in the leading indicators for several months. Looking at the recent LEI reports, "there is no sense that the U.S. or global economy is about to fall off a cliff," says Ken Goldstein, economist at the Conference Board. Of course, the LEI data in question are from June. July's reading, which will be released later this month, could tell a different story.
In order for the U.S. to enter recession, virtually all the metrics that have been signaling expansion would have to start flipping negative this month. Ken Goldstein notes that in the same way a giant tanker like the Exxon Valdez couldn't turn quickly, a $16 trillion economy doesn't shift courses on a dime. (Poor choice of metaphor, I know.) Of course, the Valdez ran aground quickly after suffering a catastrophic crash. And that's the big question. The U.S. economy in late July and early August absorbed a series of heavy blows : the debt ceiling downgrade, problems in Europe, market volatility. Were those shocks sufficiently large enough to change the underlying trends in business and consumer behavior and pitch the economy into recession? This week, the markets seem to be answering in the affirmative. But we won't have a definitive answer to that question until much later this year.
Daniel Gross is economics editor at Yahoo! Finance.