Even the most hardened of market watchers has been waiting for the powers that be to declare this recession over. Yesterday, U.S. Federal Reserve Board chairman Ben Bernanke went so far as to say that was "very likely."
But there's a difference between a partial and a complete recovery. And it doesn't pay to forget the difference.
What we're watching now is a movie we've seen before - a recession dominated by asset deflation, widespread excess capacity and deflation pressures, and then a huge shock that drags the equity market to massively oversold lows. Fiscal and monetary stimulus ramp up; hope springs eternal for a capital spending revival; and riskier assets enjoy a significant rally, as earnings and economic projections get revised higher by analysts.
But the history books tell us that in the aftermath of a bubble bust, it takes an unusually long time to embark on the next sustainable expansion.
This by no means suggests that we will not see the odd quarter of positive growth in real gross domestic product. After all, we saw two quarters of growth in 2008 and the U.S. National Bureau of Economic Research (NBER) never said the recession was over.
What we are seeing unfold is eerily similar to the events that transpired in late 2001 and into 2002, though there are two critical differences. One, deflation pressures are far more acute now, even with the dramatic government efforts to stem the tide. And two, this wasn't just a cycle solely dominated by tumbling asset prices, but one defined by the rupture of a credit bubble.
The lag between the end of the last recession (November, 2001) and the end of its bear market (October, 2002) was a reflection of the fact that it is not the official downturn that counts. Rather, it's the onset of the next sustainable economic and earnings expansion that matters most to the market.
This is a crucial point. Many pundits believe that the equity market traditionally prices in the end of the recession between three to six months in advance, but that is not really the case. What the market prices in is the onset of the recovery and there is an important distinction between the end of the recession and the expansion phase when it comes to financial market performance.
For example, in the nine post-Second World War cycles before the tech-wreck in 2000-02, recessions were essentially caused by excessive manufacturing inventories, and they generally lasted 10 months (this recession, or modern-day depression, is already heading into its 20th month).
In a garden-variety recession, it does not take very long for demand-fuelled fiscal and monetary policy initiatives to work their magic and revive the economy. What's "normal" is that after the recession ends, the economy embarks on a V-shaped recovery. That is why it is typical for the stock market to bounce roughly 20 per cent in the first year off the bottom in the business cycle. It is not so much the recession ending but the fact that initial recoveries are normally extremely buoyant.
In an asset and credit cycle, however, there is generally a longer period where the economy is no longer contracting but neither is it growing anywhere near its potential even after the recession is officially over. In this economic no-man's land, where the economy is walking through purgatory, government stimulus only cushions the blow from the lingering balance sheet repair process that is typical of an asset and credit collapse.
What happens in between the recession ending and the expansion beginning is that excess capacity in the labour and product market builds further and pricing power in the corporate sector continues to erode. So, while the recession may be technically over, it still feels like one to the market.
This is why the NBER's determination of when the recession ends is not enough to stop bear markets in their path.
Technically, there are four key economic indicators that comprise the recession call - production, employment, real sales and organic personal income. If you go back to the recessions of the late 20th century, you will see that these four indicators bottom within two months of each other. They all tell the same story at about the same time.
But, what happened in the tech-wreck-induced recession in 2001 was that there was a 24-month gap between the first indicator to form a trough (real sales in September, 2001) and the last indicator to do so (employment in August, 2003). Real organic personal income also did not bottom until December, 2002, but the NBER ostensibly put more emphasis on sales and production when it asserted the recession officially ended in November, 2001.
The reason why the equity market failed to hit bottom until October, 2002, (or even March, 2003, if you want to count the market retesting its lows) is because the economy had not yet staged a "complete" recovery.
That's why it is important to keep an eye on all four indicators and not let the rubber stamp that says "the recession is over" guide your investing decisions.
David Rosenberg is chief strategist for Gluskin Sheff + Associates Inc. and a guest columnist for the Report on Business
David Rosenberg