‘Crawl’ is the operative word since this recovery has been characterised by its chronic anaemia. Only once since the 2008-09 recession officially ended in the third quarter of 2009 has the UK’s output grown by more than 1 per cent quarter on quarter (1.2 per cent in the third quarter of 2012). So a recovery based on 40 consecutive quarters of growth, each – bar one – less than 1 per cent, might eventually produce impressive results but, while in progress, hardly seems like a recovery at all.
Yet it is axiomatic that all things must pass and since Donald Trump seems to be doing his level best to choke global trade, it is understandable that fear of a forthcoming recession should be widespread. We see it in both the fixed-interest and the equity markets where long-term interest rates have turned negative for best-quality government bonds and where shares in cyclical companies are often taking a beating.
These effects filter down to our portfolios. In the Bearbull Income portfolio shares in refinery-consumables supplier Vesuvius (VSVS) – perhaps the nearest thing in the portfolio to a bellwether of the global economy – have lost 20 per cent of their value in the past six weeks. Further behind is speciality chemicals supplier Elementis (ELM), whose shares have dropped 7 per cent since I added them to the fund but are down 28 per cent since February.
Similarly, many stocks that present themselves as candidates for the income portfolio do so because their share prices have been driven down – and, correspondingly, their dividend yields pushed up – by the cyclicality of their activities and their vulnerability to recession. More on these next week and the related matter of assessing for income portfolios companies that pay special dividends.
First, let’s major on the big picture – is a recession imminent and, if so, could we spot it coming? According to research from the Brookings Institution, perhaps the world’s most influential think-tank, the answer is “Yes, you can – quite easily”. The key is to focus on changes in a country’s unemployment rate because, say Brookings’ economists, “rapid increases in it, regardless of its level, help us quickly observe economic downturns”. Specifically, if the unemployment rate – based on the latest three-month average – is at least half a percentage point higher than its lowest level in the previous 12 months, then the economy is in recession.
Take the UK, where the lowest rate in the past 12 months is 3.9 per cent. So, for the economy to drop into recession, the latest rate would have to rise to at least 4.4 per cent. As it is, the latest rate is also the lowest, so the UK seems far from recession. However, such appearances can be deceptive. Because a recession is judged by the absence of further growth, an economy can be most vulnerable when growth has been strong. And this measure demonstrates how easily an economy can slip into recession.
For example, prior to the onset of the great recession of 2008-09, the UK’s unemployment rate had been falling for two years and was 5.2 per cent in April 2008. By September, the rate was still not high but had risen to 5.9 per cent, enough to put the UK – on this definition – into recession. Indeed, confirmation would come later in the year when data for the UK’s output in the third quarter of 2008 showed that the economy had shrunk for two quarters running, the conventional definition of a recession.
The main point of the Brookings research is that the unemployment rate reveals a recession sooner than falling output and it’s almost as accurate; at least, for the US this indicator “has virtually never called a recession incorrectly since 1970”.
Its track record with UK data does not look quite so good. Starting in 1972, we can say the following: the method missed a mini-recession in 1973-74, anticipated but exaggerated another mini-recession in 1975, beautifully anticipated but again exaggerated a long recession in 1980-81, neatly confirmed a recession in 1990-91 (again, exaggerating it), predicted a recession that did not quite materialise in 2006, was spot on with the recession of 2008-09 and, lastly, gave another false positive in 2011-12.
The full details are shown in an online table (click on the link below). The other takeaway point is that the likelihood of a recession increases as the unemployment rate rises whatever its level. Thus, according to Brookings, regardless of the rate, there is always a one-in-three chance of a recession within the next 24 months. Meanwhile, once the rate starts to rise, the closer it gets to that crucial threshold of half a point higher than the 12-month low, the greater the chance of a recession and – perhaps more important – the sooner it is likely to materialise.
For example, if the UK’s rate rose just 0.1 percentage point, the chance of a recession within the next 12 months would be negligible (about one in 12). But if the rate blipped by 0.2 points, the odds would drop to approaching one in four. In short, here’s an indicator that’s hardly infallible, but it’s easy to track and worth doing so.
