Never mind the recovery, get ready for the next recession

Aaron Task and Jeff Macke on what a huge GDP miss means for the markets and the Fed

The 1 percenters at the Milken Institute’s annual confab in Beverly Hills will be fine no matter what happens with the economy. But the next recession is on their minds, anyhow.

Many Americans are still wondering when the recovery is going to start. But by economic measures, the economy stopped shrinking and started growing in June 2009 — the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been … 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker.

“One of the things I get concerned about is, it’s about time for another recession,” Joshua Harris, chief investment officer for Apollo Global Management, said at the Milken conference. “The recovery is getting long in the tooth.”

Economic growth in the first quarter of 2014 was, in fact, nearly recessionary. Economists were expecting GDP growth of 1.2%, on average, but the economy grew by a scant 0.1%. Cold winter weather explains part of the slowdown, since it disrupted work and shopping. “This was considerably worse than expected,” Paul Edelstein of IHS Global Insight wrote. “It is therefore tempting to wonder if the economy was plagued by more than just weather last quarter.”

But few economists think a recession is imminent. Moody’s Analytics places the odds of another recession at 20%, a figure that's been falling during recent months, not rising. Even though job growth has been weak, employers have at least been hiring, and the unemployment rate falling. Some economists expect growth to pick up later this year.

No 'real recovery'

But even if there is no recession, the maturing business cycle suggests the recovery may never shift into higher gear, as millions of un- and underemployed Americans have been waiting for. “I don’t see us ever getting a real recovery,” Stanford economist John Taylor said at the Milken conference. “It looks like we’re giving up on that.”

Investors also need to adjust their thinking as the business cycle ages and the beginning of the next downturn, whenever it happens, draws closer. Some investors have only recently put money into risky assets such as stocks. But if the market begins to sniff out a recession, a selling frenzy could trap those who aren’t ready for it. “We want to make sure we’re well aware of where we are in the cycle, so we don’t get over our skis when the cycle ends,” said Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset Management, from the conference.

There are, of course, still plenty of ordinary investors who have avoided wading in to buy, even at this point, which means their portfolios have sacrificed the outsized returns of the past five years. “The market is up and a lot of people have really missed that,” Terry Duffy, president of CME Group, told Yahoo Finance in an interview from the conference.

Sluggish growth 

Plenty of things are slowing the economy, which helps explain the weakest recovery since the Depression. Consumers and governments everywhere remain overburdened with debt, which  takes a long time to work off, and in the meantime depresses spending. Rapid technological innovation — which we all see every day on our smartphones and TV plug-ins  — is reducing the need for human workers. A housing recovery that seemed to be picking up steam last year now appears to be petering out, as interest rates and home prices rise, making homes less affordable.

There’s more consensus that fiscal policy — tax and spending laws passed by Congress — has done little to help the economy since 2010. Threats to default on U.S. debt and the 2013 government shutdown have actually hurt.  “The policy paralysis that happened in the aftermath of the recession didn’t have to be like it is,” said Harvard economist Kenneth Rogoff at the conference. “Policy has been worse than nothing.”

It’s possible a lackluster recovery could last longer than a vibrant one, since there’s no overheating of the economy, which is one thing that can induce another recession. Typical hot-economy phenomena that can lead to a recession: excessive lending, spending or hiring, plus inflated prices for assets such as homes, stocks or other types of securities.

Stocks may or may not be overvalued — this is a raging debate among investors right now — but home prices are likely to drop from double-digit year-over-year gains to gains in the low single digits by later this year. 

It’s possible the distinction between a weak recovery and a recession is blurring to the point that one is indistinguishable from the other. There are still nearly 4 million unemployed Americans who have been out of work for six months or more 36% of all unemployed people — which is something that wasn't the case in past recoveries. Young people remain unemployed in record numbers, and even many working folks are earning far less than they used to. Maybe it’s the definitions of “recovery” and “recession” that need to change.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.