The Recession Debate Goes On (But These Diverging Indicators are Signaling Trouble)

June 9, 2023

If you needed any more proof about the level of uncertainty that’s permeating the economy and where it might be headed, you need look no further than this article box in the Wall Street Journal this past week…

Wrapped around an article explaining how the Saudis would now unilaterally cut production by 1 million barrels a month starting at the end of July (because the previous OPEC+ threat of group-wide production cuts beginning May 31 appears to have been a bluff) were articles both touting and doubting the strength of the US economy.

Who do you believe?

Let’s take a look…

The Good News

The “good news” article offered most of the standard economic arguments we’ve been hearing for the past year or so. 

Employers are hiring aggressively, consumers are spending freely, the stock market is rebounding and the housing market appears to be stabilizing—the most recent evidence that the Fed’s efforts have yet to significantly weaken the economy.

It went on…

Americans are splurging on the activities they skipped during pandemic lockdowns, such as travel, concerts and dining out. Businesses are staffing up to satisfy the pent-up demand. Government policies in response to the pandemic—low interest rates and trillions of dollars in financial assistance—left consumers and businesses with lots of money and cheap debt. The same inflation that so worries the Fed translates into higher wages and profits, fueling spending.

Predictably the article cited last week’s non-farm payroll number (the US added 339,000 jobs) which pretty much humiliated all the pundits who dared risk their professional reputations who offered more realistic (lower) estimates.

Indeed, if you take the report at face value*, there was some robust hiring in the month of May, specifically in the services sector: professional and business services were up 64K, health care was up 52K, leisure and hospitality added 48K and the country’s biggest employer, the government, grew by 56K.

But also predictably, the article made no mention that this recent BLS report represents only one survey and has been, at times, wildly inconsistent with other measures. You can get the full explanation here

Specifically, the 339,000 number comes from the BLS’s “establishment” survey — a survey of businesses filling jobs. The agency’s “household” survey — a look into the employment of individuals — showed a drop of 310,000 employed people. 

So 339,000 jobs were added but the number of people working had dropped by 310,000. (The article also didn’t mention that the number of people holding multiple jobs had risen by 5.5% year-over-year.) 

*BTW, I say “if you take the report at face value” because there are a couple things that aren’t well known about these surveys. For instance… 

These days the BLS has to make some serious assumptions to make their models run. Over the past 10 years, the response rate to their “Current Employment Situation” survey has dropped from 64% to a statistically questionable 42%. That means “best-guesswork” is in play on the initial preliminary number — which all eyes focus on.

Responses from survey subjects who turn in their homework late, show up one or two months later in revisions which practically no one (and certainly not the markets) pays attention to.

The other thing you need to remember are the seasonal adjustments they factor in. Like the one they made earlier this year that boosted employment numbers by some 3 million jobs.

A few months back, I noted that we’re dealing with a very different employment landscape. During the post-pandemic rebound — thanks to the shutdowns and vaccine requirements to re-enter the workforce — the US economy permanently lost some 2.4 million workers. (Again, you can read about it here.)

That means today the economy is trying to fill a pre-pandemic number of jobs with a dramatically and permanently depleted pool of workers. And the fact that we are will almost certainly continue to put some upward pressure on wages… and prices.

Speaking of Wages…

The other good news the author mentioned was that:

Average hourly earnings grew a solid 4.3% in May from a year earlier, similar to annual gains in March and April.

But as I’ve pointed out again and again, those wage gains are nominal. Adjust them for inflation and we’re witnessing the slow suffocation of workers everywhere. I put together a little table that compares average hourly earnings to inflation that shows the reality employees everywhere are facing…

(There oughta be a law that states government economic agencies can only report wage data in real (inflation adjusted) terms.)

In the end, the article suggested that a recession was possible, but they were still waiting.

Many economists and business executives say it is just a matter of time before interest-rate increases—which work with a lag—significantly sap the economy’s vigor.

Economists surveyed by The Wall Street Journal in April put the probability of a recession at some point in the next 12 months above 50%. But they have said that since October, and the recession appears no closer.

As I’ve explained before, recessions are “officially” determined by a group of economists at the National Bureau of Economic Research — usually long after you’ve been suffering through one. 

In the meantime, we may already be in one…

The Not-So-Good News

This version of the economy began by acknowledging the employment elephant in the room…

In May, employers added 339,000 jobs, bringing the total number of jobs added this year to nearly 1.6 million, a gain of 2.5% annualized.

But then hastened to add, in my opinion, a very important observation of another economic indicator that gets very little press…

But real gross domestic income, a measure of total economic activity, shrank in both the fourth quarter and the first quarter.

Have a look…

Source: The Federal Reserve Bank of St. Louis

We hear about gross domestic product (GDP) all the time. It’s the monetary or market value of goods and services that are produced in a particular country. It’s calculated as consumer spending + government spending + investments + exports – imports. And as I’ve reminded you repeatedly, the consumer spending segment makes up over 60% of GDP.

So what exactly is gross domestic income

GDI is the amount of money earned for all the goods and services produced in that country. You calculate it by adding wages + profits + interest income + rental income + taxes – production/import subsidies + statistical adjustments. Wages are the biggest component here.

Like GDP, GDI is a measure of economic productivity or output — the health of an economy. 

These numbers are essentially two sides of the same coin. And because they are, in theory, income should roughly equal spending where output goes. Of course there are reasons why the numbers don’t mirror each other perfectly…

According to the Bureau of Economic Analysis (the agency who calculates them):

In practice, GDP and GDI differ because they are constructed using different sources of information. The different source data produce different results for a number of reasons, including sampling errors, coverage differences, and timing differences with respect to when expenditures and incomes are recorded.

Economists at the Cleveland Fed agree:

The United States has two measures of economic output: gross domestic product (GDP) and gross domestic income (GDI). While these are conceptually equivalent, their initial estimates differ because these initial estimates are computed from different and incomplete data sources.

But is one number a better indicator than the other? Here you get different opinions. According to the St. Louis Fed:

Federal Reserve economist Jeremy Nalewaik explored the differences between GDP and GDI in greater detail. Nalewaik argued that GDI might be a better indicator, as advance estimates of GDI are closer to the final estimates of both measures.

The SF Fed chimes in as well:

We find that GDP consistently outperforms both GDI and combinations of the two, such as GDPplus, in forecasting aggregate economic activity during the past two years. In this sense, GDP is a more accurate predictor of aggregate economic activity than GDI over this period.

But if you look at a long-term chart, you’ll easily see that one report will be stronger or weaker than the other — but rarely is the divergence between the two so pronounced. Which makes this divergence a little troubling.

So with one measure showing signs of growth while the other is definitely indicating economic contractions, let’s cut to the chase and…

Let’s Take a Look at Productivity

Like I mentioned, both GDP and GDI are measures of productivity in the economy. So if we want a clue as to what this divergence might be signaling, it’s worth taking a look at actual productivity numbers. 

According to the BLS, who keeps track of the data, productivity is defined as the ratio of output over input. The more output increases relative to input… more productivity. And productivity can be measured in a number of different ways: as an individual worker’s productivity, or a company’s, or an industry’s or even a country’s.

The chart below is the BLS’s productivity index which calculates output per hour for the nation…

Source: The Federal Reserve Bank of St. Louis

You can see that productivity has been declining noticeably since the second quarter of 2021. That’s a significant downturn over the past few years. But even looking at a long-term picture, you’d say it looks pretty dramatic…

Source: The Federal Reserve Bank of St. Louis

And you’d be right. 

In fact, none other than the BLS reported that this was the first time that year-over-year quarterly reports had been negative for five consecutive quarters.

Source: The Bureau of Labor Statistics

So What Do We Make of This?

I feel a little sorry for the writer who drew the short straw and got the “Where’s the Recession?” article.

With employment numbers that are seriously questionable, and real wages that have been declining for nearly two years, it’s got to be a challenge to make a case for a strong economy. (Even if you do have the NBER on your side for now.)

Other consumer numbers haven’t gotten any better either.  

Starting in mid- to late-2022, personal savings (which was rapidly drained of all the stimmy cash it was flush with just a year and a half before) had managed to swing to the upside. It was both a good sign and a troubling one. Good that consumers were attempting to save some money. Bad in that the reason they were was likely because they sensed bad times ahead.

Source: The Federal Reserve Bank of St. Louis

But that boost has taken a downtick as of April.

And consumers are still flexing their credit cards more than ever…

Source: The Federal Reserve Bank of St. Louis

Now add to that the falloff in national productivity — a major factor of economic growth — and things may not be looking so bright.

Paul Ashworth, chief U.S. economist at Capital Economics, noted that GDI had similarly diverged from GDP most noticeably going into the 2008 financial crisis…

Source: The Federal Reserve Bank of St. Louis

An observation worth noting.

I don’t expect the current divergence is signaling something as severe as 2008. But given all this, maybe GDI is on to something…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential