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If I had to guess, I’d say the economy is in a recession right now. That’s not exactly a brilliant insight. It seems pretty obvious just by looking at equity prices.

Next week, the government will deliver its first report on Q3 GDP and I’m expecting a dismal number. Or rather, whenever we get the final report on Q3 GDP, I expect a dismal number. The problem with GDP reports is that they’re subject to constant revising, so it takes along time, several years in fact, to find out how well the economy is really doing.

A better measure is the unemployment rate. This, too, is imperfect, but it’s good at giving us a look at direction. And that direction has been nothing but down recently. The jobless rate reached 4.4% last March and got to 6.1% in September. If the rate gets to 8%, and we’re already nearly halfway there, that would be a 25-year high. I think 8% is very possible.

We’ll also get a good look at how the economy did in the third-quarter from corporate earnings. This week, one third of the companies in the S&P 500 report. Earnings for the S&P 500 will probably drop about 10% for the third quarter. There’s a lot of guesswork involved but the earnings declines will most likely continue through the first half of 2009.

The Wall Street Journal notes:

Top-down estimates of 2009 earnings range anywhere from $87 a share down to $60 a share. An average of a handful of such forecasts is that earnings will fall roughly 10% next year to about $73 a share. Thus, Wall Street's consensus may be overestimating earnings by at least 25%. Still, that means the S&P is trading at about 13 times forward earnings -- also a relative bargain.

That forecast also assumes earnings will bottom early next year, resulting in at least a 10-quarter earnings decline of 30% from the 2007 peak to their trough. That would roughly match the 1989-91 earnings downturn, which also started with financials, lasted 10 quarters and shaved about 24% off earnings.

The problem with looking at this market isn’t valuations. Equity prices were never in a bubble. The problem was that fundamentals cracked, and we don’t yet know where bottom is.

Posted by edelfenbein at October 20, 2008 7:03 AM