“Four factors used to determine recession:

1) Employment

“The NBER relies on four different variables. The first is employment. Now I’ve told you before; employment is down seven months in a row. Does employment go in the GDP? The answer is no. Is it correlated? Yes. Does it help grow the business cycle? Of course.

2) Industrial production

“The next variable is industrial production. Does that go into GDP? The answer is no. Does it help grow the business cycle? The answer is yes. This is a number that comes from the Fed. The GDP comes from the Commerce Department. It’s a very important variable.

3) Real personal income net government transfers

“The next variable, the third one, is real personal income excluding government transfers. This metric is now down four months in a row. Does personal income go into GDP? The answer is no; of course, it doesn’t. GDP is all about spending. Personal income goes into gross domestic income, which is another chart of the national accounts.

4) Real sales activity

“The fourth variable and the only variable that actually feeds into GDP is real sales activity in manufacturing, retail and wholesale sectors.

“A Recession probably started in January. When I take a look at these four key indicators that define the broad contours of the business cycle, they all peaked and began to roll over sometime between October of last year and February of this year. I am convinced that when the NBER does make the final proclamation, it will tell us that a recession officially began in January. Of course, to any market person, this would make perfect sense, because of when the S&P 500 peaked. It did a double top into October, right when it usually does, before a recession begins.

“This recession won’t end before mid-2009, in our view. Now I’m just giving you the rearview mirror. What’s most important to you folks is let’s look through the front window and see when this recession is going to end. The tea leaves that I’m reading at this point in time show that this recession is not ending any time before the mid part of 2009, which would mean that, if you’re looking for, not the Mary Ann Bartels intermediate bottoms, but the fundamental bottom, I don’t think you can expect to see it before February or March of next year, if I’m correct on when this recession ends. Historically the S&P 500 troughs four months before the economy actually hits its bottom point.”

I agree with Rosenberg. And if we see a recession lasting into 2009, then earnings are going to be under a lot of pressure. Buying index funds today could be very risky to your portfolio.

What’s a Central Banker to Do?

Central bankers everywhere are faced with a serious dilemma. Do they raise rates to fight inflation, cut rates to stimulate their economies, or sit tight and hope that prices moderate as the world economy slows? Hope is an interesting strategy for a central bank, but it may have come to that.

In short, the world has not decoupled, but is more closely intertwined because of the global financial community. Housing problems and excesses in California (and the rest of the US, the UK, Spain, etc.) affect banks in Europe and Asia and the US simultaneously.

You cannot have a worldwide recovery until the financial crisis in the major lending institutions is dealt with. A functioning banking system is the lubricant for a world economy, and the banking industry is cutting back on loans and tightening the standards by which they do make loans. Look at these survey results from Northern Trust:

In reality, it is not just mortgage lending that is getting tighter. Every survey done on any type of lending worldwide shows bankers are setting tougher standards; and most are simply lending less, partially as a result of shrinking capital ratios. Until lenders have adequate capital to be able to make loans, it will be hard to see anything other than a very tepid recovery sometime next year.

Look at the graph below. The spread of the difference between US 10-year treasuries and a 30-year mortgage is the highest in over 22 years. In May of 2007 it was 1.37%. Today it is 2.53%. The historical average is 1.68%. That means a mortgage costs almost 1% a year more than it would under a normally functioning market. That reflects that lenders are having trouble finding investors who will buy their mortgages, and of course it makes housing less affordable and puts off the day when inventories will again be reasonable.

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