So, this is a recovery?

Unemployment is at its highest level in 26 ½ years at 10.2%, but this understates the fact it has only reached double digits twice since the 1930’s (1982 and today). Housing prices are down, bankruptcies are up and yet commentators keeping yelling “recovery!” at every turn. Is this what a recovery feels like?

The short answer is “yes”. The National Bureau of Economic Research or “NBER” is the official arbiter of the business cycle. The committee determines the actual start and end dates of the business cycle. Despite its name, NBER is actually a private, nonprofit, nonpartisan research organization which is why they are the de facto umpire of business cycle dates. NBER defines a recession as (emphasis mine) a “significant decline in economic activity spread across the economy, lasting more than a few months…a recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and the next peak, the economy is in an expansion.”

More precisely, a “recovery” is the early phase of the “expansion” before the level of economic activity reaches its previous peak. It means the economy has hit bottom, but is not necessarily strong or hitting new highs. A hypothetical diagram of GDP over time might help:

As you can see from the chart, economic activity near the trough is still down from the peak level. That means higher unemployment, declining sales, weak profits, etc., but the trajectory is up and things have stopped getting worse.

Just about every indicator has firmed in the last couple of months with the only exception being unemployment (unemployment is a lagging indicator and will improve only after everything else does). A few months do not make a reliable trend and NBER has not actually declared the recession over (which hasn’t stopped many strategists from doing so and this optimistic sentiment has helped continue the stock market rally). In fact, it looks as though the economy may continue to improve, at least for the next quarter or two.

One significant component of this improving economy is that inventories are extremely low across the economy. When the recession took hold, companies slashed inventory to free up cash and run lean. As sales continued to slide, they reduced inventories even further. Today, inventories may be ripe for a rebuilding to more normal levels. As new orders come in, suppliers order inventory so they can meet demand. Then their suppliers must also order and a chain reaction takes hold which can materially boost the economy in the short run. This sentiment has been reflected in recent earnings reports and management conference calls. Will the inventory build hypothesis for improvement in GDP play out? Stay tuned.

Latest data point on chart: Oct-09