The payroll data on Friday re-ignited talk about the "R" word.  But the overall data don't indicate that the economy is anywhere near entering recession. 

A Minor Payroll Drop Set off Hysteria

Nonfarm payrolls fell from 138,041,000 in July to 138,037,000 in August.  The accompanying press release noted that payrolls were therefore essentially unchanged.  The decline of 4,000 is well within the margin of error of the sample method and much smaller than the average revision to the change with the following month's data. 

The annual benchmark revisions to the payroll data also can change the picture.  In March of 2007, the 2006 payroll data were revised upward by 752,000.  That is an average of 63,000 a month.  The statistically insignificant drop of 4,000 in August could easily get turned around by revisions.

One month of a statistically insignificant decline does not signal a recession. 

Further Considerations on Employment

The trend in payrolls is clearly weak.  The average payroll gain the past three months is just 44,000.  Financial and construction firms are announcing layoffs.

Yet, layoffs are not occurring across the broader economy to an abnormal degree.  This is reflected in the fact that weekly unemployment claims are at low levels from a historical standpoint and nowhere near recessionary levels.  Businesses are cautious and not hiring, but not necessarily laying off people. 

At the same time, business investment continues to rise.  Nonresidential investment was up at an 11.1% rate in the second quarter in the GDP data, and durable goods new orders for July were up 5.9%. 

Overall business spending trends are cautious, but not moving into recessionary patterns.

Consumer Spending

Recession advocates have another critical fact that can not be ignored - consumer spending trends remain steady.

Consumer spending is almost two-thirds of the GDP calculation.  There is no sign that it is declining. 

In the second quarter GDP numbers, consumer spending was up at a sluggish 1.4% annual rate.  That has since picked up.  Inflation adjusted personal consumption expenditures were up 0.3% in July.  August is likely to also post a gain given the solid retail chain store sales and auto sales already announced.

There simply is no evidence that consumer spending is weakening as in a recession.

Furthermore, the argument that consumer spending has to fall given the decline in payrolls simply does not add up.

A statistically flat payroll number needs to be adjusted by wage increases to assess the change in total consumer spending power.  And hourly earnings were up 0.3% in August and are up 3.9% over the past year.

Even if payrolls stay flat, a 3 1/2% (or more) annual rate of increase in wages increases spending power by that amount.  That figure then has to be adjusted for inflation (up 2.1% over the past year for total PCE).  It isn't boom times, but there is still clearly an increase in consumer spending power. 

Housing

The housing market is in the tank.  There is no arguing with that. 

Yet, it is now almost two years since housing started to decline.  Right from the start, there was talk about how a weak housing market would drag the consumer down and the economy into recession. 

It was almost exactly a year ago that the Big Picture analyzed what the impact of housing would be on the economy.  Our conclusion that housing was in a corrective mode that would create sluggish economic growth for over a year, but that it would not lead to a major negative wealth effect on consumer spending that would lead to a recession, has been correct.  That is still our position. 

The housing market is a major factor on the economy, but it will not lead to a retrenchment in consumer spending or a recession.

The Fed

Perhaps the biggest problem for the recession argument is that the Fed has said they will act as necessary to support the economy.

They have plenty of ammunition to use.  They will probably lower the fed funds rate at the September 18 meeting, and that will create expectations of further rate cuts.

This doesn't mean the Fed will move as quickly as the markets would like.  The Fed wants a housing and liquidity correction, and a sluggish economy. They don't want 3% real GDP growth yet.  But they also don't want a recession, and they will lower rates to prevent that from happening.

What it All Means

The stock market sell-off on Friday is arguably justified if it reflects a re-assessment of overly optimistic hopes of what a potential Fed rate cut will do for economic growth.  It is not justified, however, to the extent it reflects the incorporation of a significantly higher probability of a recession.

There is simply still no evidence that real GDP growth will go negative in the third or fourth quarters, or in 2008.

In fact, almost all economists continued to forecast about 2% real GDP growth in the second half of this year.

There are always risks.  Business confidence could collapse, and consumer spending could retreat.  But a more likely scenario is that rate cuts restore some confidence, and the consumer maintains the same approach of the past three decades - if you  got it, spend it.

The real bottom line is this - the Fed wants sluggish economic growth.  That is how underlying inflation rates are brought down.  Furthermore, and seldom mentioned, the Fed wants a higher unemployment rate.

That is what is behind the regular wording in the FOMC statements about high resource utilization creating inflationary risks.  That is a reference to tight labor markets (historically low unemployment rates). 

The Fed is happy to see payroll gains slow.  They aren't going to panic with flat payroll growth.  They might lower rates to reduce the downside risks to the economy, but they aren't going to lower rates to get payroll gains back over 100,000 a month.  It has taken a long time to get to this point by simply holding rates steady.  They aren't going to back down now.

Economic growth has been sluggish for a year and one-half and will remain that way for a while.  There is no reason to panic, however, over a flat payroll number that reflects the softening in the labor market that the Fed has been seeking.  That number will neither greatly change economic forecasts, or earnings forecasts for that matter.

Our stock market view is still only Neutral, but we certainly aren't turning bearish over the fact that one month of payroll  data happens to have a negative sign in front of it.