Fearing Red Herring in the Data

David Leonhardt|The New York Times

Only a month ago, a recession looked inevitable. Job cuts were picking up speed, and stock prices were falling. The Federal Reserve was cutting its benchmark interest rate rapidly, in an effort to keep the downturn from snowballing. But the notion that the economy could avoid a recession altogether seemed fanciful.

It looks less fanciful today. The economic news hasn’t exactly been sunny lately, but there also haven’t been any nasty new surprises. If anything, the economy seems to have stabilized. The pace of layoffs has eased a bit, stocks have risen and the Fed has signaled that the rate cuts are over for now.

And now the economy is being flooded with cash, courtesy of the federal government, and that will surely lift consumer spending in the months ahead. Two weeks ago, the Treasury Department began distributing the tax rebates from the recent $168 billion stimulus package. The effects of the Fed’s interest rate cuts, meanwhile, are still washing over the economy.

So you can make an argument that the economy has survived its period of maximum danger. On Intrade, the Web site where contracts tied to real world events are bought and sold, traders now think there is only a 29 percent chance the economy will shrink for two straight quarters this year. In mid-April, they put the odds at 70 percent. Edward Lazear, an economic adviser to President Bush, gave an upbeat interview to The Wall Street Journal last week in which he suggested a recession was now unlikely.

Yet no one is really arguing that the economy is in good shape. Ben Bernanke, the Fed chairman, noted in a speech on Tuesday that there had recently been “some improvement in financing markets” but that those markets were “still far from normal.”

What, then, are we supposed to make of the latest batch of better-than-expected news? Here are four indicators that cut through the daily swirl of data — and provide perspective on the newfound optimism.

HOUSING Mr. Bernanke has suggested that the financial system, and the economy, won’t be out of the woods until the housing market bottoms out. But there are two different meanings of “bottoming out,” and it’s important to keep them separate.

The first, which is the one Mr. Bernanke seems to have in mind, describes the point at which the real estate market is no longer getting worse at an accelerating pace. That may, in fact, be close to happening. In the most recent numbers, overall home sales were down 20.8 percent compared with a year earlier. At the end of last year and the start of this year, the declines were 22 to 25 percent.

This version of bottoming out is an important benchmark, because it will give people a tangible reason to believe that the bust won’t last forever. But it certainly will not be the end of the bust. For that to happen, home sales will have to begin rising again.

And home sales won’t start rising until prices fall significantly more, to a point where the typical family can afford the typical house without the help of a wishful-thinking mortgage. We’re not there yet. In a survey released Tuesday by the Philadelphia Fed, economists predicted that prices nationwide would fall 12 percent more this year, hold steady in 2009 and not start rising — albeit slowly — until 2010.

PROFITS After Tuesday’s slight decline, the Standard & Poor’s 500-stock index is still up almost 10 percent from the recent low it hit in mid-March. “Many on Wall Street,” as my colleague Vikas Bajaj recently wrote, “seem to think that the worst is over.”

To figure out whether they’re correct, don’t watch the week-to-week movements in the market. Instead, pay attention to corporate profits.

Corporate profits have just emerged from a historic boom. From 2002 to 2007, inflation-adjusted pretax profits rose more than 50 percent. But they’re not rising anymore. They are likely to end the current quarter 7 percent lower than they were a year ago, according to Global Insight, a research firm.

The big issue here is that current stock values are based on the idea that the profit boom wasn’t a bubble. Investors are assuming that profits will bounce back quickly — and justify today’s stock prices. If profits do rebound, stocks may hold up or even keep rising. If not, the market is going to start looking very expensive very quickly.

JOBS The unemployment rate gets the most attention, but it isn’t the best measure of the job market. A better indicator is the monthly change in overall employment. (The unemployment rate doesn’t count people as unemployed when they have given up looking for work, as I’ve described before. The rate is also based on a far, far smaller survey than the employment numbers.)

In each of the last four months, employment has fallen. These declines left the economy with fewer jobs in April than it had six months earlier. Over the last 50 years, this six-month comparison has been a perfect predictor of recessions. Whenever employment has declined over six months, a recession has been under way (or recently ended).

The story with jobs is similar to the story with profits. If the economy doesn’t start adding jobs in the next month or two, we’re in a recession. The next employment report will be released on June 6.

PAY Even in a recession, the overwhelming majority of Americans keep their jobs. So the main way that a downturn affects workers is through their pay: it rises more slowly than inflation, forcing most workers to take an effective pay cut.

First comes weaker economic growth, then come layoffs and, finally, come the pay cuts — because workers have little leverage. The economy started slowing late last year, and in the last two months, weekly pay growth has slowed markedly, leaving it well below inflation. This, in turn, creates problems for the broad economy. On Tuesday, the Census Bureau reported that retail sales rose only 2 percent over the last year, down from more than 4 percent for much of 2007.

When you step back and look at the whole picture, you see an economy that clearly seems a bit stronger than it was a month or two ago. The government stimulus now coming into the pipeline may well allow growth to stay above zero and for an official recession to be averted.

To me, though, the odds of a recession still appear to be better than even. I don’t know how else to read the recent employment declines. Historically, when the job market has deteriorated as much as it has recently, it enters a vicious cycle of layoffs, stagnant pay, weak consumer spending and yet more layoffs.

And even if that cycle is averted this time, the main economic story line for 2008 already looks clear. Further declines in housing prices are baked into the cake. The same goes for weak wage growth. Recession or not, it seems unlikely that the economy will feel healthy to most people anytime soon.