Job Data Suggests US Recession Is Here: Merrill

Source : The Business Times, January 10, 2008

Never in past 60 years has jobless rate risen 60 points without a recession

A US recession is a reality, says Merrill Lynch in a Jan 7 report, calling for a defensive strategy and investments in high-quality bonds.

The firm's North American economist David Rosenberg said last Friday's employment data 'strongly suggests' an official recession. For one, the unemployment rate hit 5 per cent in December against the March 2007 trough of 4.4 per cent. At no time in the past 60 years, he wrote, has the jobless rate risen 60 basis points without the economy slipping into recession.

Back-to-back declines in total hours worked - this indicator saw a 0.4 per cent fall in the fourth quarter, against a 0.6 per cent fall in the third - is also associated with a recession.

Another point is that the level of unemployment is up 13 per cent year-on- year, which is consistent with a recession. The year-on-year rate of change in the level of the unemployed who have been idle for at least 15 weeks is 'particularly ominous', he said, at 20 per cent. This was the pace in the early stages of previous downturns in 2001 and 1990.

The typical recession, he said, lasts 10 months, and sees the S&P 500 decline 60 per cent of the way through. '... so if you're in the market for bottom picking, the historical record would be telling you to wait for May or June. Based on how the markets end up behaving peak-to-trough when the economy moves into a recessionary phase, we can see that right now the S&P 500 is priced 32 per cent of the way for a recession; and no sector is fully discounting this condition.'

Mr Rosenberg favours Treasuries and high-quality bonds. 'We maintain our call not to be afraid of low yields but to focus on adding income and quality to the portfolio'. Treasury bonds, he said, outperform stocks on a total return basis by 2,700 basis points during a cyclical bear market, 'so bonds are the place to be'.

In a recession, the Federal Reserve cuts the funds rate by an average of 400 basis points. Both the Fed funds and long-term yields also continue to decline after the official downturn is over. In recessions, the S&P500 typically corrects by about 25 per cent.

The worst sectors are consumer discretionary and financials; the best performing are defensives like telecom, healthcare and utilities. The latter sectors may outperform the market by 400 basis points. 'But keep in mind that all 10 S&P sectors are down in a recession, so there is nowhere really to hide.'

Mr Rosenberg warns that the unwinding of the real estate bubble could prolong the current downturn. But assuming a typical scenario, the recession could end around the fourth quarter of 2008. This suggests a market bottom in mid-year, 'But by that time, an average recession would imply another 15-20 per cent downside to the equity market and is not a train you want to stand in front of... This then means a focus on defensive strategies.'

Separately, Reuters reported Goldman Sachs as saying yesterday it expects the US economy to drop into recession this year, prompting the Federal Reserve to slash benchmark lending rates to 2.5 per cent by the third quarter.