Knowing where the economy stands is more difficult for share investors than it seems. Ron Bewley explains
The threat of a possible recession in the Australian economy late last year sent a chill down the spine of most investors. As we stand today – and if we use the simplistic “two consecutive quarters of negative growth” definition – we are probably some time off being able to call a recession, given that the last quarter turned out to be positive. Most commentators now argue that by the end of the year, the US economy will have stopped falling, if not started to grow – and China is already steaming ahead. Before we pop the sparkling-white-wine corks, let’s take out some of the hype from the last six months’ economic commentary. Five facts got lost in the panic that was the investment sentiment of the time.
Fact 1. The “two consecutive quarters of negative growth?” definition of a recession is not useful and is not used in the US. In 1961, Julius Shiskin published an NBER paper of more than 150 pages defining recessions, entries and exits. Several of his requirements for a recession were written up in a New York Times article in 1975. So who is responsible for chopping down his substantial definition to just six words?
Fact 2. Recessions characterise periods of economic pain caused by hard times. At the time of writing, the latest unemployment figure was 5.7 per cent for the month of May. Instead of talking about half-full and half-empty glasses, let us look at the facts. Which of the following statements do you prefer?
- May’s unemployment was the highest in five-and-a-half years, or,
- May’s unemployment was the lowest between 1978 and December 2003 – bar six months spread over the good times of 1981 and 1989 when unemployment reached as low as 5.4 per cent”.
Both are correct. Only one puts the current state of play into perspective. Unemployment at 4 per cent was never sustainable. People were leaving good jobs to flee to the west to work in the mining industry at inflated salaries; it seemed rare to find anyone but backpackers serving in cafes; Gen Y ran rampant with its worklife balance demands (and we didn’t stop them).
Fact 3. There are three standard ways of defining Gross Domestic Product (GDP): the sum of all expenditures (consumption, investment et cetera); the sum of all incomes (wages, profits et cetera); and the sum of all production (from different industries). When calculated independently, the three numbers (largely derived from surveys) are not equal. The Australian Bureau of Statistics (ABS) has jointly estimated them since the mid-1990s, to force them to be equal – resulting in a measure called “statistical discrepancy”. In plain English, the statistical discrepancy is the “bit we can’t find”.
Given that the last two quarters for GDP have been -0.5 per cent and 0.4 per cent respectively, the fact that the contribution of statistical discrepancy to GDP growth was -0.5 per cent and -0.7 per cent respectively means that the bit we can’t find has been equal to or bigger than the number published in the last two months! If underlying growth is flat (0 per cent) and the statistical discrepancy is random, there is a 50 per cent chance of getting a positive (or negative) outcome. The chance of getting two consecutive quarters of negative growth then rests at one in four. The chance of not getting two consecutive quarters of negative growth is three times as likely! That is part of the reason why we don’t get too many recessions.
Fact 4. GDP data get revised. The 1990 recession was heralded as the worst in 60 years. The June quarter 1990 came in at -0.9 per cent, and the September quarter at -1.6 per cent. With the benefit of hindsight, these numbers were revised to be -0.2 per cent and -0.5 per cent – tiny by comparison.
Fact 5. The Australian economy stood up well to the Asian crisis, the “tech wreck”, September 11, SARS and bird flu. At the time, economists ducked for cover; but in each case we avoided “two negative quarters”. Perhaps we will similarly avoid the global financial crisis (GFC). So where does this leave us? The results of a survey of 7500 people in 24 nations, reported in www.smh.com.au (May 26, 2009), placed Australia as the most likely to survive a recession – China second.
Twenty per cent of respondents put Australia first. Should we have listened to them? “Dr Doom” (Professor Nouriel Roubini), the one-time very negative Professor Shiller and Nobel Laureate Professor Paul Milgrom have all called an end to the gloom they predicted last year, with Shiller even quoted as saying: “We could have a huge rally like the 1933 to 1937 rally.” (Sydney Morning Herald, May 9-10, 2009.) Of course, unemployment is likely to worsen, but until it climbs above about 8 per cent from 5.7 per cent, unemployment will be below the average from 1978-2003! I don’t recall the past 30 years as being all that bad.
