For the last several months we have been posting our Economic Output Composite Index and warning that it was heading to levels that typically denote that the economy is in a recession or about to be in one.   With today's read of the Philadelphia Fed Regional Manufacturing Survey coming in a not just contraction levels but a massive collapse to the downside, as we have been saying was a possibility, the EOCI index is now at levels signaling recessionary warnings.

(The EOCI Index is a weighted average of the Fed Regional Manufacturing Surveys, the Chicago Fed National Activity Index, The NFIB Small Business Survery, Leading Economic Indicators and the STA Composite ISM index)

In our recent blog post "Are We Headed For A 2nd Recession", (Updated July 31st, 2011), we stated that "With the recent release of the Chicago Fed National Activity Index, our proprietary economic index is just one small step away from crossing the 35 mark which has always been a pre-cursor to recession."  Today that indicator is showing a reading of 26.74.

We have discussed many times recently that the unemployment rate remains high, housing prices are slipping into a secondary decline, consumer and business spending is slowing, while gas and food prices remain high, eating up more than 20% of consumers wages and salaries. Add on top of these factors the likelihood of a Greek debt default, a slowdown in the Euro-zone, a weaker dollar and political infighting without resolutions in Washington, inflationary pressures mounting on the consumer — well, the list of risks far outweigh the positives.

The plunge in the Philly Fed index today was, as I said, not surprising even though it surprised the economists that were actually expected the number to increase.   I can't figure out why they would expect it to when every other indicator continues to show signs of economic weakness filtering through the system.   I will admit that the decline was deeper than even I expected but the trend of the movement has been evident for months.

Digging down into the survey we find that New orders fell to minus 26.8 from plus 0.1, shipments minus 13.9 from plus 4.3, number of employees minus 5.2 vs plus 8.9, unfilled orders minus 20.9 vs an already dismal minus 16.3. Price data show a contraction for output prices and a much slower rate of inflation for input prices. Delivery times improved significantly which is another sign of weakness.  The six-month outlook also crumbled, coming in above zero but just barely at 1.4 vs July's 23.7. The Empire State report, released Monday, also showed 3 months of continued contraction which is also a recession pace as well.

It doesn't take an economist to figure out that any one of these factors could send us tumbling into a second recession. However, that doesn't seem to deter Wall Street economists and main stream media, who all seem to be wearing rose colored glasses these days.   Even after the dismal economic news that has persisted over the last several months analysts and economists are still "hoping" that the economy will somehow avoid a recession.   More disturbingly, however, is that they are still recommending to invest into stocks that currently are not priced to reflect the impact of an earnings growth decline due to a recessionary economy.   Analysts are still predicting near record earnings growth and the reality is that if the economy slips into a recession we could see earnings decline to near $75 from current levels which is a far cry from the $105 level predicted for 2012.

It is disturbing that policymakers, while the say they have the weapons, do not seem to have fortitude or political willingness, or maybe it is just the lack of insight, to fight the current economic malaise. The policy measures that have been used to date have been ineffectual at creating organic economic growth as they have not targeted the root of the problem which is excess debt and jobs.   With consumers restricted due to declining wages on a year-over-year basis and inflationary pressures rising the lack of final demand is keeping businesses from hiring.    These problems are a large reason why the economy is more vulnerable to another recession as the policy measures that were used to drag forward future consumption leave a massive void when they are withdrawn.   While we expect that the Fed is willing to step in, just like it did in 2009 and 2010 with Quantitative Easing - the reality is that those programs were a failure in terms of creating economic stability, employing labor or resolve credit issues with consumers.    While another injection of QE might stabilize the markets short term it won't serve the long term economic needs.  

Furthermore, it is important to realize that we are not in a normal manufacturing business cycle economic slowdown.  This is a balance sheet recession the likes of which have only been seen in Japan and during the "Great Depression".   Unfortunately, economists and analysts and politicians keep trying to cure a normal business cycle recession rather than a balance sheet recession.   By utilizing the wrong medicines for the illness the symptoms might temporarily dissipate but the underlying infection continues to destroy the system.   As history has shown, financial crises are often followed by very prolonged rolling recessions.   Take a look at Japan as a study and you will see an economy that has struggled with recessions on a rolling 3 year basis rather than the 8 year basis we have witnessed since World War II.  Long periods of sustained high unemployment, low growth and weak financial markets which mark these periods do not bode well for individuals trying to retire within the next 10-15 years .  

The safe play in the current environment is hedged investments, cash and fixed income for the current time.   This has not been, nor will it be any time soon, a "buy and hold" investing market.   The management of risk, the conservation of investment capital and the generation of total returns from portfolios is paramount for investors to survive the cycles that we will face in the coming years.