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Chart In Focus

Proof The Double-Dip is Coming

 
Chart In Focus
 
June 11, 2010


I keep hearing the question offered in the financial media about the possibility of a "double-dip" recession, and so far the answer to that question by the "experts" is nearly uniform.  The consensus seems to be that we will not see a double-dip recession.

As an aside, we have collectively lost some accuracy in our economic terminology.  100 years ago, it was proper to refer to any economic slowdown as a "depression", much as one would describe a low point in the ground.  A depression consists of 3 parts: the recession (going down), the bottom, and the recovery (going up).  Thus, the economy can be in recovery mode, and still be in a depression, much like climbing uphill but still being in a valley. 

The slowdown episode in the 1930s was tagged as the "Great Depression". That term was coined during a period when "The Great..." was a modifier that got applied to lots of different things.  WWI was "The Great War", F. Scott Fitzgerald wrote "The Great Gatsby", and author Jack London coined the term "The Great White Hope" which referred to a boxer who whites hoped would finally defeat boxer Jack Johnson, a black man who was the heavyweight champion from 1908-1915.  In the years that followed The Great Depression, no one wanted to conjure up the mental images of something as bad as that 1930s period, so economic slowdowns were just referred to as "recessions".  Some in the media have even taken to referring to the economic slowdown of 2007-10 as "The Great Recession".

Back to the double-dip.  Most economic indicators are now showing growth in the U.S. and worldwide economies, and short term interest rates are starting to rise again.  The 6-month LIBOR (London Interbank Offered Rate) had gotten down to as low 0.34% on February 17, 2010, and it is now back up to 0.76%.  I have found that lumber futures prices give a great leading indication of where short term interest rates are headed, and thus of future economic activity.  Turning to this week's chart, the plot of lumber prices is shifted forward by a year to reveal this lead-lag relationship. Interest rates follow the same dance steps, with admittedly less volatility, about a year after those movements are seen in lumber prices.

Lumber itself bottomed on January 29, 2009, almost exactly a year ahead of the February 17, 2010 bottom in the 6-month LIBOR.  That LIBOR rate is now rising, as an echo of the initial rise in lumber prices in early 2009.

But as we see in the chart, that initial rise in lumber prices led to a "false breakout" above the downtrend line, after which lumber prices came back down to make a double bottom in late 2009.  If the LIBOR rate continues to follow the path of lumber prices like it has in the past, then we are in for a dip in short term rates into late 2010.

The most likely explanation for why the 6-month LIBOR (and other rates) should fall later this year would be an economic slowdown, or at least the perception of one in the financial markets.  In other words, lumber prices in 2009 have already mapped out the path of the "double-dip" recession that people have been worrying about.

The good news is that lumber prices rose dramatically out of that second bottom in 2009, nearly doubling the price of lumber in just 7 months. That move tells us that short term interest rates should rise rapidly starting from a low in the autumn of 2010 and continuing into early 2011.  I suspect that the financial media will attribute this economic surge to investor reaction to the mid-term congressional elections, even though the surge has already been written into the script by lumber prices. 

But the flip side of that good news is that in the past 2 months, lumber prices have lost 1/3 of their value seen at the April 2010 top, so the big surge in the economy in early 2011 could fizzle pretty quickly.

Tom McClellan
Editor, The McClellan Market Report


 
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