The 2001 Recession is a Bad Example

Our suggestion that there were a few promising economic signs drew a number of comments about the 2001 recession.  Some note that the market continued to decline for many months and another 40% after the "official" end of the recession in November of 2001.  The implication is that the same might or will occur this time.  This is both poor reasoning and a bad example.

Only One Example?

It is poor reasoning because circumstances are always a bit different.  Why expect this recovery to be the same as the 2002-03 period rather than some other time?  The ECRI work that we cited, now helpfully posted in more detail at The Big Picture, sees the recovery as fitting many past patterns.  There are not that many recessions and recoveries to use.  It is better to use as much relevant  data as possible.

2001 Was Atypical

There are two important reasons why the 2001 -03 era was atypical.  Perhaps because the leading economics bloggers were less active during this time, none of them seem to have noted these facts.

  1. 2000 was an unprecedented peak in labor participation.  Between the Y2K problems and the Internet startups there was tremendous demand for specialized workers.  Even the COBOL programmers were pulled back into the market.  Many companies chose to dodge the problem by buying new computers.  This pulled demand forward and further increased employment.  We will probably never again see such a peak in labor force participation.
  2. After 9/11 it was clear that the US was going to engage in war with Iraq {corrected from typo, Iran}.  There was a prolonged dance with the UN while we tried to build a coalition.  It was a time of uncertainty.  In reaction to this uncertainty, US companies delayed expansion and hiring.  It was an easy choice.  Why act when you could wait a few months and see how it would turn out?  We watched this over and over in CEO interviews.

The result was that demand and hiring was pulled forward to 2000, creating an impossible high.  When the recovery came, it was distorted by the altered computer cycle and also the delay for the start of the war.

This was an easy target for Democrats in 2004, so we got the term "jobless recovery."

2009 Is Different

Most obviously, the 2009-10 recovery will not operate from a prior peak in labor force participation.  There is plenty of room to get back to old levels.  Also, there has been no pull forward in demand.

Just as importantly, there is unprecedented monetary and fiscal stimulus, just starting to hit.  This is an important and significant difference.

Our Take

No one knows exactly how this will play out.  We have maintained that it is a challenge for any existing models, including the ECRI's, for which we have the most respect.  Quite frankly, we wonder if the ECRI model will accurately reflect the stimulus impact.

While employment always lags as companies squeeze more work out of an existing force, there is much more potential for a rebound.  There is no a priori reason to expect a jobless recovery.

Meanwhile, corporate earnings from lean companies continue to surprise.

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  • Michael Harr July 21, 2009  

    Definitely agree with your post. 2001 was almost a snooze economically speaking. While the depreciation in stock prices can harken some recollections of the 2000-02 decline, what we are experiencing is much wider and deeper in scope. We are seeing asset values decline across the board with only a few non-traditional asset categories showing increases.
    The net result is a loss of capital across the board and with the deepening debt, the fiscal stimulus comes with a price we haven’t paid in the past–questions of creditworthiness.
    I like Richard Koo’s take on this in that when studying economics, we always assume firms are maximizing profits. What is happening now is that firms are cleaning up balance sheets by minimizing debt. This presents a host of other questions that I don’t believe have been clearly answered–even with Japan’s fine example of a devastating recession with broad and deep asset value declines.

  • Mark Wolfinger July 21, 2009  

    “Meanwhile, corporate earnings from lean companies continue to surprise.”
    Do they really?
    Revenues are terrible. Cutting costs only goes so far.

  • Mike C July 21, 2009  

    Most obviously, the 2009-10 recovery will not operate from a prior peak in labor force participation. There is plenty of room to get back to old levels. Also, there has been no pull forward in demand.
    In this post, you do not mention the debt issue at all in terms of credit outstanding as a percentage of GDP, or perhaps more importantly the current status of the consumer/household balance sheet with respect to debt and future access to credit as a factor that could impact the economic recovery or employment.
    I’m curious. Do you believe this is a complete non-issue or overstated, and if so, do you care to expand on that.

  • Jeff Miller July 22, 2009  

    Mark – You are right, of course, about revenues. What more could the owners of companies ask than continued earnings in bad times.
    I am expecting costs to remain low during the early part of a recovery in revenues. Those who track forward estimates are already seeing a reaction in those numbers.
    From your comment, it sounds like you are expecting further revenue declines. Thanks for your observation, and please elaborate.

  • Mark Wolfinger July 22, 2009  

    I don’t really have more to say.
    I don’t pay close attention to earnings reports. I just happened to notice that each of the companies that were mentioned as contributing to a up day in the market beat earnings estimates – but with substantial decreases in revenue. In fact revenues were below estimates.
    That does not bode well for the future.

  • Jeff Miller July 22, 2009  

    Mike — I’m sure you understand that I cannot cover every economic topic in every article. My point here was to respond to those who seem to think of 2000 as a template for this year, perhaps expecting poor stock market returns for more than a year after an economic recovery begins.
    I have written about debt a number of times, but perhaps another article would be timely. Thanks for the suggestion. Meanwhile, I’ll just note that improvement in debt ratios requires improved income, employment, and tax revenue. At some point we will return to what I have called normal and sensible lending.

  • Mike C July 22, 2009  

    From your comment, it sounds like you are expecting further revenue declines. Thanks for your observation, and please elaborate.
    I’ll chime in. Sales per share are trending down:
    I agree with Mark that this does not bode well. The problem is (I think) you can’t just keep cost cutting your way to hitting earnings as sales decline.
    Seems to me there is the potential here for a vicious negative feedback loop. In the aggregate, the S&P 500’s employees are also its customers (at least the consumer spending portion and its impact on the entire food chain). The more you eliminate employees to “cut costs” the more you send the signal to consumers to cut back spending even more and sales continue to decline. I wonder how far corporate management’s think they take this without realizing they are laying off their customers for their products.
    Where do sales stabilize?

  • Jeff Miller July 22, 2009  

    Mike and Mark — Sorry to be unclear.
    The stocks I own have a significant foreign component. The trend is influenced by Asian economies as well as currency.
    If you think that the economy (and revenues) are still in a free-fall, and you also believe that the current market reflects something else, then your bearish stance is correct.
    I think that stocks were priced for a depression post Lehman, and worse after the attacks on Obama policies. For someone with that viewpoint, there is plenty of running room, even with things getting “less negative.”
    I also expect revenue gains as the fiscal and monetary policy lags play out. My key winners have been Intel, Goldman, Apple, and Cat, all delivering on earnings.
    Simply put, the economic indicators are stabilizing, and that means that revenues should as well. Any pop in revenues will mean great earnings.
    Thanks for the opportunity to elaborate on my viewpoint.

  • Mike C July 23, 2009  

    If you think that the economy (and revenues) are still in a free-fall, and you also believe that the current market reflects something else, then your bearish stance is correct.
    Just to be clear for the record, I’m not bearish here. I’ve got no short positions, and am roughly 60-70% invested in equities with a 30-40% cash position. I was bearish (correctly I will note) in 06 and 07 with the S&P at 1300-1500 (and this is documented in my past comments).
    I’m basically neutral here. According to the valuation models I consider predictive of long-term returns, the S&P is basically fairly to reasonably valued here at 950-970. Technical factors appear also to be supportive of an extended rally here in the market
    ”My upside price target is about 1200 on the S&P 500. I have to say that this doesn’t make any sense considering what I think I know about the economy, which is why I try to ignore fundamentals in favor of the charts.”
    That said, however high this rally ultimately goes, I suspect the end result will be similar to 2000 and Oct 2007, and that the gains will not be sustainable but temporary, and the key will be to know when to sell, take your chips off the table, and go home, and wait for the next time the S&P revisits the 600-800 level.
    If history is any guide, we are still many years away from a long-term sustainable bull such as 1982-2000.
    As to the strength of the economic recovery, and what the market is pricing in, I’m not sure but I am trying to figure that out. Some interesting comments from David Rosenberg’s daily note:
    Martin Feldstein, professor of Economics at Harvard and is the former head of the National Bureau of Economic Research (NBER), said in a media interview on Tuesday that “there is a real danger this is going to be a double dip and that after six months or so we’ll have some more bad news.” He sees, as well as the consensus, that the U.S. economy will likely come in with fractionally positive growth in 3Q. However, that could be it for the good news as fiscal stimulus programs are ending and companies finish rebuilding their inventories.
    “There is a real danger this is going to be a double-dip…” Martin Feldstein
    Well, the S&P 500 surged 15% in the second quarter and what we did was go back in the history books to see what happens to the economy the very next quarterly typically after such a big bounce and the answer is … just over 3% real GDP growth. So consider that de facto what is being discounted at this time for current quarter growth — it better be a humdinger of an inventory build. Now, for the market to build on such a rapid advance in the current quarter, history again suggests that we would need to see 5½% real GDP growth, which we give near-zero odds of occurring. Hence our call for a sputtering stock market through year-end. Too much growth — and hope — is priced in at this point.