Brad McMillan, Contributor
Nov. 23, 2020
With the number of new coronavirus cases hitting all-time highs, the pandemic continues to dominate the headlines. In addition to the worries over the tragic medical damage, there are growing concerns that the economic recovery is also at risk. Indeed, this is a legitimate fear. But when we look beyond the headlines and at the actual data, the story is very different—that we may be closer to the end of the recession than we think.
When assessing the economic risks, four main indicators come into play: year-on-year job growth, year-on-year changes in consumer confidence, business sentiment, and the spread between 10-year and 3-month U.S. Treasury security interest rates (often referred to as the yield curve). Three of those four—the real economy indicators—all say the recession is ending sometime soon. The fourth, the yield curve, started to say the same thing, but then it got cut off by Fed policy. If it were free to speak, it would probably be saying good things as well.
All of these indicators have good records as recession predictors individually. In concert, however, they are rarely wrong. So, it’s worth it to think hard about what they are saying, despite the headlines.
What Are the Economic Signals Saying?
Job growth. After the dramatic drop in jobs at the start of the pandemic, we have seen substantial recovery over the past six months. In the past two months, job growth was over 600,000 per month, despite the third wave of infections now underway. The headlines have focused on how we are still 10 million jobs below where we were before the pandemic. But I want to call your attention to a different stat: job growth in the past two months, despite the third wave, has been at more than three times the level we saw pre-pandemic. The healing continues, despite everything, as businesses need more people.
As an economic signal, this is a significant positive, but it gets even better when we go back to history. In the past four recessions, job growth dropped before and into the recession. But when it picked up again, the recession was over or nearly so. With six months of job gains under our belts, if the past four recessions are any guide, we may be moving out of the current recession as well. Even if we need some more healing (which is quite possible), at current job growth rates, we should be there in the next several months. Based on jobs, we look to be much closer to the end of the recession than the beginning.
Consumer confidence. We see the same thing with consumer confidence. It dropped significantly at the start of the pandemic, but it has since bounced back. Year-on-year, confidence is down about 25 points, which is the breakpoint where the past four recessions have ended. Yes, it might take some more time. But by next March, the year-on-year change will be strongly positive if current levels hold. That outcome is likely given current expectations, which would certainly take us out of the trouble zone and back into expansion. Looking at expectations, that might well happen even sooner. Again, we may be much closer to the end than the beginning.
Business sentiment. Business confidence is even simpler and more encouraging. The ISM Composite index is a diffusion index, where values above 50 mean confidence and expansion and those below 50 mean contraction. The index bounced back up into expansionary territory back in June and has held there since. In fact, businesses are now more confident than they were in 2019, much less early 2020. By this metric, the recession is already over, and businesses are looking to hire and expand—which is exactly what we are seeing.
The yield spread. For the final indicator, the yield spread, the story is more ambiguous. Typically, the spread between the 10-year and 3-month Treasury rates has to rise to 2 percentage points or more. Now, we are at only 69 bps, so not even close. Given Fed policy, however, specifically designed to keep rates down, and the generally lower level of rates than prior recessions, this indicator may be less reliable. The Fed has simply refused to allow rates to rise, so this indicator can’t move into the positive zone.
Fed-driven low rates, however, are not an argument for continued recession but, rather, the opposite. The simple fact is that low rates are stimulative, as we are seeing in the housing industry. Far from keeping the economy from recovery, low rates are helping it along. On the whole, this still looks like an indicator that the end of the recession is not that far away.
Is the End in Sight?
The economic data is telling us that we are approaching the end of the pandemic recession. When we look outside the economy, though, this conclusion seems very inconsistent with the medical news. But the economy is not the pandemic. We see signs of adaptation to the pandemic in the economy, as with the jobs and confidence news, and an increasing disconnect between the medical news and the economic news. As that adaptation continues, it makes sense that we will return to growth even without controlling the virus. If we do control the virus, which now appears likely with the positive vaccine news, then the news could be even better. Either way, the end of the recession is very possible even with current medical news.
The rally in financial markets, in the face of the pandemic, also makes much more sense if the recession is ending. To justify current prices, the economy has to normalize sometime in the next 12 months. That outcome is exactly what analysts and markets are predicting. The stock market has a good record of predicting recoveries, and that is just what it is saying now.
The Outside View
There are lots of reasons to worry. The third wave continues to get worse, and none of the good news is guaranteed. When we take the outside view, however, and look at the data rather than the headlines, the outlook is much better over time. We can’t ignore the damage and the human tragedy of what is happening now. But, equally, we should not ignore the positive signs that say we are still moving forward and that, on many fronts, things are better now—and will be better still in the future—than they seem.
By Brad McMillan, Contributor
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