Recession Watch: the economic indicators that show what's coming

Summary: As the expansion ages and growth slows, we should begin to watch for signs that the next recession approaches. Here are some tips for doing so without spending much time at it — avoiding the complacency of Wall Street’s economists and the exaggerated darkness of the popular permabears (such as Zero Hedge). {2nd of 2 posts today.}

What should we watch among the blizzard of economic data? Journalists tend to focus on the numbers most frequently reported, usually about manufacturing and housing. Such as this week’s existing home sales volume (oddly, we don’t similarly obsess over NYSE volume). It’s important for people in that biz, but tells us little about the US economy.

Also big in the news are new home sales, building permits, mortgage applications, and many other housing datapoints. For a simple measure of this industry see total residential construction spending. It shows a continued strong expansion. Tune in next month to see if anything has changed.

What are the most important economic numbers?

But the often dramatic graphs don’t tell us the importance of those numbers. Here’s one perspective on the big picture…

Construction value added: 4% of GDP (housing is 1/3 of this).
Goods-producing value added: 19% of GDP (manufacturing is 12% of this).
Services value added: 68% of GDP.

Another way to see this relationship: manufacturing new orders were 15% of GDP in 1995; now they’re only 10%. Manufacturers employed 30% of all non-farm workers in 1955; they employ only 9% today. Manufacturing was once the key swing sector of the economy; now we are a services economy. Unfortunately there are few good leading indicators for the service sector. Creating Purchasing Managers Indexes for Services was a creative idea, but untested — and doesn’t make much sense to me: what do they PM’s of service corps do that gives them special insight about the economy?

Another perspective

Watch labor, one of the — or perhaps the — major engine of the economy. New claims for unemployment are a sensitive indicator of labor markets, a powerful leading indicator, and hard numbers reported in real time — but they’re noisy. Claims have given a tentative warning, as their rate of improvement slows.

A lesser-known indicator should also be near the top of your watchlist: the Fed’s Labor Markets Conditions Index. Like GDP, it is a mind-bendingly complex indicator — a useful single number providing one aspect of the broad economy. Unlike GDP they report it monthly. It’s flat-lined after five years of slow improvement. Not in decline, but giving a clear warning.

The bottom line

If you want to follow just one indicator, watch the Atlanta Fed’s GDPnow model. It’s roughly as accurate as economists’ forecasts, but It is updated 5 or 6 times per month.

Conclusions

The US economy has flown into what pilots call the “coffin corner” — unable to accelerate, but much slowing probably would cause a crash. But economists remain confident, as they were before the 2001 and 2007-09 recessions. With their eyes firmly on the rear view mirror, they see that the usual causes of recessions are absent.

We are in a new era. Don’t assume history will repeat. Watch the economic data to see the unexpected turbulence that will end this already old expansion.