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Seasonal adjustment issues are not distorting the economic outlook [ClearOnMoney]
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Seasonal adjustment issues are not distorting the economic outlook

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Commentary

Seasonal adjustment issues are not distorting the economic outlook

28 Mar 2012 by Jim Fickett.

A claim is circulating that seasonally adjusted data are unreliable and, by looking beyond that data, using year-over-year changes, a clear worsening is beginning to show in the US economy. Looking at the indicators used by the NBER business cycle dating committee, we show this is completely false. Certainly the recovery is fragile, but it remains on course for now.

It is currently fashionable to suggest that the big drop in US economic output in Q4 2008 and Q1 2009 skewed seasonal norms, making seasonally adjusted data for subsequent Q4s and Q1s look unnaturally good. There might be some level of truth to this claim, though the view is obviously too simple – the big drop in output was spread, at least to some extent, over much of two years, not just two quarters.

It is difficult to quantify and check the seasonal adjustment distortion claim per se, but the popular view often goes on to make a more important claim that is easy to check against the data. The second claim is that, by looking beyond the seasonal adjustment, using year-over-year (YOY) changes, one sees a worsening US economy. This is just plain false.

Lest I distort the message, here is one example of the current reasoning, from TeamThink:

the significant collapse in the US economy in 4th Quarter 2008 and 1st Quarter 2009 has wreaked havoc on the seasonal adjustments ever since, as outlier data typically do with statistical models. One way to try and normalize for these seasonal adjustment issues is to look at year over year numbers rather than month over month or quarter over quarter. …

Using year over year economic data, the US economy has been getting modestly worse over the past five months in all the major categories on which recessions are determined.

This particular source doesn't say exactly which indicators they have looked at. One natural set to examine would be the one used by the NBER for business cycle dating. Two years ago William Hester at Hussman Funds provided a very nice overview of the indicators used by NBER:

The NBER defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators.” The four primary indicators that the group tracks are: Industrial Production, Real Manufacturing and Trade Sales, Real Personal Income Less Transfer Payments, and Nonfarm Payrolls. …

[The committee] “places particular emphasis on real personal income excluding transfers and on employment, since both measures reflect activity across the entire economy.”

Let's look at the YOY change for each of the primary four NBER indicators.

I've recently shown a graph of the YOY change in industrial production, which is looking a bit sluggish, but not in any way alarming:

Does this really show the US economy getting “modestly worse over the past five months”? No. There was a bounce after the recession which was overdone, and since last May, when that bounce had subsided, the YOY change has been 3.6% +/- 0.6%, that is, roughly constant within the noise tolerance of this series. If you think small recent changes do matter, then you need to explain why, if the economy is worsening, the latest change was from 3.1% to 4.0%.

Growth in real manufacturing and trade sales (from NIPA table 2BU) also shows no decline. To the contrary, through Dec 2011, the latest data available, the YOY change was clearly in an uptrend, and looked nothing like previous slowdowns:

Growth in real household income less transfer receipts might be slowing, and comes the closest of the four to supporting a gloomy outlook. But growth in income might also be steady. Over the last 10 months the YOY change has been in the range 2.6% +/- 0.7%. Considering that there are clearly noise spikes in the graph well over one percentage point high, it is impossible to say with any confidence that the income growth rate is not just bumping along at a pretty steady level.

The YOY change in non-farm payrolls has been in an uptrend for two years. I've said many times that I'm worried that uptrend won't continue. But for now it continues, and it is simply wrong to say that this indicator, one of the central two used by the NBER, is indicating a worsening economy. The opposite is true.

All told, looking at the YOY change in the key NBER business cycle indicators provides no evidence that the economy is worsening.

Of course many of those who claim to see the economy currently worsening also claim that things are likely to get much worse soon. Maybe; I'm not arguing about any particular future scenario. As far as I know, growth may continue or it may not. What I am arguing is that (1) the evidence is clear that the recovery continues for now, and (2) those who claim to see that the economy is about to go downhill have provided no clear evidence to support their claim.

It is best to limit yourself to keeping a close eye on current conditions, and to actually look at the data to do so. That is all you can do, and it gives you enough information to assess risks realistically. The current state of the economy is, as it has been for some time, a rocky and fragile recovery. If all goes well, the recovery will continue. If China's slowdown, Europe's debt crisis, or tensions between Israel and Iran escalate, the US could very easily get knocked off course. You simply have to be prepared for both possibilities, because no one really knows which it will be.