Wednesday, 3 December 2008

NBER drives home the message: This is BAD

Forgive me for being a little bit confused. For years, friends and colleagues working in the financial sector have told me that what happened yesterday is of no importance to the stock markets. What counts is what happens NOW and what is expected to happen in the (near) future.

Monday, nevertheless, the stock markets sold off on news that a group of economists had decided that the US economic recession began in December 2007. Why, one could ask, is it suddenly so important now. Particularly since everybody has understood that we are in a recession.

National Bureau of Economic research, NBER, is a privately funded group of economists, but its board has won the privilege of officially stating when recessions begin (and end). Being professional economists, they use a wider set of economic indicators than the rest of us (you have probably heard of the definition: two consecutive quarters of negative GDP growth), employment, manufacturing, industrial production, retail sales, and income.

Their role has never been that of "playing politics", meaning that their definitions were meant for use when designing economic policy. Instead it is a rather academic exercise, aimed at academic economists and analysts looking at the really long trends. NBER established that the previous recession ended in October 2001 and the US had 73 months of growth. But then employment peaked in December 2007, Personal Income in the same month, while manufacturing and retail sales had peaked in June 2008. Industrial production peaked in January 2008.

Maybe it has to do with perceptions of the recession. Some pundits were already getting into the futile game of guessing the "shape" of the recession. Would it be V-shaped (short and sharp) or U-shaped (taking a little bit longer to recover from)?

Then this bunch of economists tell us that the recession has already lasted for 11 months. The longest recessions of the post war era were both 16 months long (73-74 and 81-82). Worse, there are absolutely no signs of this recession abating. If anything, the downturn is still accelerating. Car sales continue to collapse, employment is falling, retail sales are still falling. Repossessions of residential property is accelerating, so are defaults on home loans. And we have still not seen the commercial property sector give in despite rumours, and there have still not been any marked increase in corporate defaults.

NBER's statements made it clear to even the most starry-eyed optimist that this recession is at least going to be longer than anything we have seen this side of WW2. It has also the hallmarks of being deeper than anything seen since the '30s.

There you have it. The combination of NBERs statements and the continued flow of really bad news drove home the message to everybody: the point of reference for this downturn is not any longer any recent recession, but the depression. Understandably, the stock market took cover and the oil prices resumed their fall.

Then in a twist of brilliant irony, the markets began to rally again. Now the arguments were turned on their heads again: now we know it is so much worse than what we believed last Friday. So now we cannot be surprised badly any more. So let us go and buy some stocks.

Suddenly, yesterday began to look so – yesterday. I have argued earlier that this recession is going to become deep because of the debt overhand, compounded by the banks' various follies in the derivatives markets. I am afraid I have still seen nothing that will make it likely that the stock markets could not become negatively surprised again.

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