Serious Money: The waiting is over. The United States's debt-laden economy has reached its moment of truth. Economic data released during the first trading days of the new year was unambiguously weak and suggests strongly that an economic recession is no longer a matter of deliberation, but a harsh reality, writes Charlie Fell

The peddlers of blue-sky thinking will undoubtedly continue to assign subjective probabilities to the likelihood of a downturn in 2008, but such dubious analysis should be consigned to the dustbin as the said event has already arrived.

Financial markets are not easily fooled and US stock prices have registered their worst start to a new year since 1932. Equity returns over the past 15 months now trail that of US Treasury bills over the same period. A bear market has taken hold.

The Institute for Supply Management's (ISM) manufacturing survey for December was released on the first trading day of the year and revealed that the composite declined for the sixth consecutive month and dropped below the break-even level of 50 for the first time since last January.

The weakness was widespread, with the readings for both new orders and production falling below 50 and the former reaching its lowest level since the last recession. Indeed, the share of respondents reporting declining orders exceeded the share citing rising orders by two-to-one.

Importantly, with much of manufacturing depending on the recent strength in exports, the export index dropped sharply from 58.5 in November to 52.5 last month. The share of respondents reporting declining export orders surged to the highest level in four years.

Across-the-board weakness suggests that a manufacturing recession has begun.

Stock prices responded badly to the ISM report and equity investors endured further agony when the Bureau of Labor Statistics (BLS) released the employment report for December last Friday. The number of jobs added last month fell well short of expectations at 18,000, compared with a consensus estimate of 70,000.

Private-sector payroll employment dropped 13,000 last month, the first decline since the summer of 2003. Year-on-year growth in total payroll employment slowed to less than 1 per cent, while the unemployment rate registered its largest month-on-month increase since 1995. At 5 per cent, it has increased appreciably from its cycle low of 4.4 per cent last March. The slowdown in year-on-year growth in total payroll employment and the surge in the unemployment rate are both consistent with the onset of a recession.

The notion that a downturn has arrived is corroborated by the fact that the headline numbers may overestimate labour market reality due to the BLS's birth/death adjustment.

The adjustment attempts to account for the new jobs created by small businesses that have not appeared on any radar screen and thus cannot be contacted by the bureau, and the jobs lost due to the failure of small businesses.

The adjustment is necessary because net job creation by the small business sector is the engine of economic growth.

Unfortunately, the adjustment is estimated from the births and deaths of small businesses over the previous five years, which means that the payroll numbers reported are lagging. The data consistently overestimates labour market reality during the late stages of an economic expansion and reveals that employment is recovering long after a recession has ended.

Indeed, the adjustment accounted for more than 90 per cent of all the jobs created since the start of the year as against 45 per cent in 2006 and 32 per cent in 2005. The adjustment totalled 66,000 in December, versus payroll gains of just 18,000, which suggests that the labour market is contracting.

The data released in the first week of 2008 reveals that the US economy slipped into recession in December.

Optimists will argue that two consecutive quarters of negative growth are unlikely due to strength in the export sector.

Their thinking is suspect. Firstly, the sharp drop in December's export order index casts doubt on the idea that the rest of the world can decouple from a sluggish US economy. Indeed, economic growth appears to be slowing rapidly across the euro zone and Britain.

Secondly, two or more consecutive quarters of negative growth is not the criterion used by the US National Bureau of Economic Research to define a recession. It looks at a number of indicators, with most emphasis on the monthly employment report, and labour market data is already symptomatic of a downturn.

Investors should no longer deliberate on whether a recession will hit in 2008, but focus instead on how protracted and severe the downturn will be.

The stock market is beginning to believe the inevitable, having dropped more than 10 per cent from its October highs, but further weakness lies in wait.

Cash is king for now.

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