July 2009

Consumers are peeking out of their financial foxholes, spying signs that the “Great Recession” is retreating and hoping that new growth will start to emerge yet this year.

There are plenty of indications that a bottom is in place. For example, consumer spending, which accounts for more than 70% of U.S. gross domestic product (GDP), rose at a 1.35% annual rate during the first quarter versus the 4.3% decline posted during the final three months of 2008. Similarly, real GDP fell at an annualized 5.5% rate during the first quarter 2009 after contracting 6.3% during the fourth quarter 2008.

Other areas of the economy also are signaling an end to the decline:

• Home sales are picking up and the rate of decline in prices is moderating
   
• Job losses have slowed despite high continuing rising unemployment
   
• Core inflation levels remain under control
   
• Manufacturing seems to be nearing the bottom
   
• Consumer and small business sentiment have improved
   
• Credit markets are thawing and perceived credit risk appears to be moderating
   
• Investor risk appetite shows signs of increasing

Leading indicators lead
Perhaps the best summarizing statistic for the economic outlook is the index of Leading Economic Indicators (LEI). “The year-over-year percent change in this index does a good job of identifying turning points in the overall economy,” said Paul Kasriel, Northern Trust’s chief economist. “The rate of decline in the year-to-year change in the LEI has slowed significantly, suggesting the worst of the recession is likely behind us.”

But just because we see “green shoots” does not mean the economy will bound upward. Shell-shocked consumers are unlikely to lead the spending charge that typically powers economic growth. Instead, these may portend a timid recovery with wobbly legs.

“Unfortunately, household net worth has been clobbered, and debt as a percentage of assets has hit an all-time high. This will keep a lid on spending and likely lead to a weak recovery during the fourth quarter this year,” Kasriel added. “The message is that an outright economic recovery still lies ahead.”

Kasriel isn’t alone in his thinking. In the Federal Reserve’s Beige Book, five of the Fed’s 12 regions reported that consumer spending stayed soft in late spring, although the downward trend in economic conditions is showing signs of moderating.

“The Fed is in a watch-and-wait mode,” added Asha Bangalore, Northern Trust economist. “The coast is not clear, and more signs are necessary to declare the recession has ended,” she said.