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The telltale signs of recession

Here are four indicators with good track records at predicting downturns. Watch them to see where the economy is likely to go next.
/ Source: Business Week

The economic data are taking on a new urgency. Recently, a few of the economy's vital signs have been erratic. Most notably, a popular measure of service-sector activity plunged to an all-time low, and payrolls last month posted the first monthly decline in nearly 4½ years. The trouble is, that's what the data often do when the economy is sinking into recession: They surprise, sometimes shockingly, on the downside. Most reports in the coming weeks will almost certainly look glum. But just how glum?

Economists' expectations have dropped sharply in only the past four weeks. The 51 forecasters surveyed by Blue Chip Economic Indicators now expect first-half growth to average only 0.8%, down from their 1.6% projection in January, and the number of outright recession forecasts is growing.

More negative data surprises would validate the pessimists' view. However, four indicators will be especially important over the next few weeks: new filings for unemployment insurance every Thursday, the February manufacturing and nonmanufacturing indexes from the Institute for Supply Management (ISM) on Mar. 3 and 5, and the Labor Dept.'s February employment report on Mar. 7. Why these? They are timely, indicative of broad business trends, and sensitive to swings in activity, and two of them were unexpectedly weak in January.

Start with the labor markets. Payrolls don't just edge lower in a recession, as they did in January, falling 17,000. They drop like a stone. In the 2001 recession, for example, which began in March, job gains slowed to a mere 15,000 per month in the first quarter of the year. Then in April they plummeted 281,000, with losses averaging about 200,000 per month for the rest of the year. In a 2008 recession scenario, February's job report would revise January payrolls to show a larger loss, and February employment would drop 100,000 or so.

Weekly unemployment claims gave a warning of the big 2001 job losses, and they would likely do the same in 2008. By mid-March in 2001, the four-week average of claims had jumped to about 390,000 new filings per week, up from about 340,000 in mid-December. Right now, claims are averaging 335,000 through early February. That's consistent with nothing worse than anemic economic growth, suggesting slower hiring rates rather than rising layoffs. Based on past trends, the four-week average would have to jump into the 375,000-400,000 range to foretell recession-like job losses.

How to read the ISM data
All eyes will also be on the ISM's index of nonmanufacturing activity, mainly service industries, for confirmation of its January swoon, to 44.6, from 53.2 in December. Readings under 50 indicate business is contracting. The index goes back only to 1997, so comparisons to earlier recessions are shaky. But based on the index's past relationship with economic growth, its January level, if maintained for the quarter, would be consistent with a highly unlikely double-digit plunge in real gross domestic product. Also, the sharp decline in the employment component of the overall index would imply payroll losses during the quarter averaging nearly 160,000 per month.

The drop in the ISM's nonmanufacturing index contradicts the ISM's manufacturing gauge, which has a better and longer record at spotting recessions. Over time, the two have tracked each other fairly well, but the factory index rose in January, to 50.7 from 48.4, which did not put it at a recession level. Historically, a nonmanufacturing index at January's nadir would be associated with a manufacturing reading of about 42, which would set off alarms. The recession script now? February's nonmanufacturing index would fail to rebound enough to take it out of the danger zone, while the manufacturing gauge would reverse course and join it there.

Economic reports other than these four will also be important in divining the economy's path in the first half. However, if the numbers are going to start singing recession, this quartet will lead the chorus.