The Recession Is Here | Seeking Alpha

There are two variables that investors should always watch to get some idea of when a recession is coming or when a recession has arrived.

The two variables are Industrial Production and Capacity Utilization.

These statistics are produced monthly and tend to move very closely with figures on real Gross Domestic Product.

The variables tend to be biased toward the “real” part of economic output, not taking in things like services, but they still tend to capture movements in the economy that are a little bit ahead of the more general changes that most people look at.

Industrial Production

The Industrial Production index (IPI) is a monthly economic indicator measuring real output in the manufacturing, mining, electric, and gas industries, relative to a base year.

Furthermore, although these sectors contribute only a small portion of gross domestic product (GDP), they are highly sensitive to interest rates and consumer demand.

Hence, they tend to move in a downward direction in the early stages of an economic recession.

Here is the recent data on Industrial Production.

Although it has taken a couple of dips earlier in the current period of economic expansion, the series now seems to have peaked in September and October 2022 and is now moving in a downward direction.

In other words, the fourth quarter of 2022 seems to be the first quarterly move in this variable since the very short recession in 2020.

Yes, it is early, but it is a warning sign that the recession is upon us.

Capacity Utilization

Capacity utilization is the extent to which a firm or nation employs its installed productive capacity (maximum output of a firm or nation). It is the relationship between output that is produced with the installed equipment, and the potential output which could be produced with it, if capacity was fully used.

Capacity utilization tends to move downward as the demand for goods drops off and firms use less of their capacity to produce a smaller amount of output.

Here is the recent data on Capacity Utilization.

The peak in capacity utilization came earlier than the peak in industrial production. The peak in this cycle came about in April, and although it did not really drop off much for the rest of the summer and fall, capacity utilization dropped significantly in November and December 2022.

Thus, both of these series give us a feeling that the top of this economic cycle came somewhere in the summer or fall of 2022 and has continued through to the end of the year.

Tying The Two Together

I know that the movements in both series do not look all that great, but the important thing is that they move together and have done so on a regular basis historically.

And, note, although there have been some “false signals” occurring during the past sixty years, the pattern is pretty consistent. When manufacturers’ capacity utilization turns downward, it generally continues downward for an extended period of time.

Furthermore, when the recession hits, capacity utilization really drops.

So, this is something we need to watch out for.

But, this is true of industrial production as well.

Notice that in this chart there only seems to be one “false” start, in the 2014 period.

When industrial production goes down, a recession eventually occurs. Sometimes, right away. Sometimes after a few more months.

Is The Recession Here?

My feeling is that the recession is here and will continue on for a good part of 2023.

My reason for feeling this way is that the Federal Reserve has caused the M2 money stock to decline.

The M2 money stock began to decline in March 2022, the time that the Federal Reserve began its efforts to combat inflation.

The decline has progressed and even accelerated as the Federal Reserve continued its program of quantitative tightening.

It is my belief that the Fed will continue on with its quantitative tightening and this will continue at least through the summer of 2023.

And, with quantitative tightening continuing, the M2 money stock will continue to decline.

Guess what?

If this happens, I believe that you will continue to see industrial production fall, and you will also continue to see capacity utilization fall.

Real Gross Domestic Product will not be far behind.

The recession is coming if it is not already here.