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Will our Recovery technically be a Recession?

November 26, 2010

I am starting to wonder about our next recovery.  I suspect that while we will have something that feels really good to the consumer, we might technically have a double dip recession!

Our inventory build up has been so large and the change so dramatic, that we must slow down inventory growth – it is all but a certainty.  Additionally, inventories get drawn down during fast expansions – it is difficult to build inventories when facing a deluge of orders.

Combine a deluge of new orders, plus low future orders according to the ISM, and record inventory growth, and you have a recipe for negative inventory growth.

The change in growth in inventories is what impacts GDP.  If inventories are growing at a constant pace -say 30bn a quarter – it has no impact on GDP.

Slowing inventory growth subtracts directly from GDP.  So if businesses start to slow inventory growth to normal levels, plus there is unexpected strength from the consumer which further bites into inventories, we could see inventory growth get crushed.  And that could easily push us to a negative GDP.

Here are the really, really good circumstances in the economy right now:

  1. Corporate Profits are high
  2. Upper Income Consumer Spending Picking Up (They are all that matters to U.S. corporations anyway)
  3. Consumer Confidence looking up

Inventory buildup is at record levels. We had had a huge inventory buildup.  This is likely to be a rather large drag on the economy over the next few months.  Check out what Albert Edwards has to say about this:

Now you won’t need reminding that it is the change in growth in inventories that counts towards GDP growth. So even if inventories rise another $110bn in Q4, as they did in Q3, the contribution to GDP growth is zero. If inventories rise a still strong $60bn in Q4, for example, inventories will deduct 1.5% from annualised GDP growth. With final sales rising a sickly 0.75% annualised (!!) over the last two quarters, you don’t have to be a genius at maths to realise a recession is entirely possible, even without sharp declines in housing or consumer durables.

That is strong language, but even more importantly, it is likely to be true. We could have GDP due to consumer spending pickup and corporate spending of 2.5%, but have inventory growth of only 30bn, and have a negative GDP print.

Check out the size of this potential slowdown in a chart from the same Albert Edwards at Soc Gen.  The divergence looks to be the largest on record.  And remember, We could easily see negative growth if we have lots of consumer spending.

Note that I got the inventory slowdown part of this post from the Business Insider.   The Business Insider is an excellent site.  And of course, Albert Edwards is excellent, even if he is a perma-bear.

The idea that we may have an economy that feels like it is in recovery while is technically in a recession is mine.

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