Respected fund manager / economist John Hussman argues that the US is entering a "double dip" on the basis of four criteria that, in combination, have identified the last seven recessions (at least). Hussman used the approach in late 2007 to anticipate the 2008-09 contraction.
The criteria are:
1. Wider credit spreads than six months ago.
2. A moderate or flat yield curve, defined as a yield gap of no more than 3.1 percentage points between 10-year Treasury bonds and three-month Treasury bills (currently 2.9).
3. A lower stock market than six months ago, as measured by the S&P 500 index.
4. A manufacturing purchasing managers' index (PMI) at or below 54 coupled with non-farm employment growth of less than an annual 1.3%.
The PMI condition in the fourth criterion has yet to be fulfilled but Hussman argues that this is likely based on recent weakness in the weekly leading index (WLI) compiled by the Economic Cycle Research Institute (ECRI). Indeed, the WLI can be used instead of the PMI and yields nearly identical historical results, with the criterion already met.
Are there any reasons for thinking that "this time could be different"?
One doubt concerns the employment condition in the fourth criterion. In the last seven recessions, the annual growth rate fell beneath 1.3% from above. Employment is currently still lower than a year ago. Is a recovery in growth to above the critical level necessary before a new recession signal can be generated?
In earlier work, moreover, Hussman used a slightly different formulation, with a simpler fourth criterion – a manufacturing PMI of below 50 – and a lower critical value of 2.5 percentage points for the 10-year / three-month Treasury yield gap in the second criterion. Both formulations signalled the recent recession but only the modified version is currently giving a warning. Hussman, presumably, would argue that the new model is superior and provides more of a lead; the old version is likely to follow in due course.
The view here has been that narrow money trends are not yet weak enough to suggest a second recession. The chart shows a US real money measure that has weakened ahead of 10 of the 11 recessions since the second world war, the exception being the 1953-54 downturn, which was triggered by a large fall in government spending following the end of the Korean war. The measure has continued to rise recently, albeit at a slowing pace.
US fiscal policy is scheduled to tighten significantly in 2011 but it is doubtful that the economic impact will be as great as the post-Korean-war cuts – government spending on goods and services fell by a real 6.8% in calendar 1954, cutting 1.64 percentage points directly from GDP.