RICHMOND, Calif.--(BUSINESS WIRE)--Brian Pretti, chief investment strategist for East Bay-based Mechanics Bank, has one word for those who keep saying the nation is not yet in a recession: "Bunk."

"We are still wringing out the excesses of the financial sector," Pretti says, "and not only is the period of reconciliation--or deleveraging--not over, but we will be living with it for some time to come. We're in a recession; there's no other word for it."

Then why don't the numbers tell the story?

"Officially, a recession is defined as two consecutive quarters of negative, inflation-adjusted, gross domestic product (GDP) growth. But if you use the wrong inflation assumptions (called the deflator in the GDP reports), the conclusions are wrong, too."

To illustrate, Pretti points to recent deflator factors used by the Fed to estimate GDP. "For the first quarter 2008, it was 2.7%, for the fourth quarter 2007, 2.4%, and 1% for third quarter 2007," he says. "Where did the government come up with those numbers that are quite different than the CPI numbers? Since September 2007, the price of crude oil is up 100%; retail gasoline up 69%; natural gas 95%; and the Commodity Research Bureau index for foodstuffs is up 27%. The true nature of inflation in the US has been anywhere between 4-5%, and that means we’ve already been in a recession for a number of quarters.”

The year-over-year inflation as measured by the Consumer Price Index rests at 4.9% as of the June report, which was released yesterday. It highlights Pretti's point--and calls into question the prior figures that have been used. "No wonder the financial markets aren't buying the idea that the economy is 'holding up,'" Pretti says. "Their negative behavior is telling us headline GDP numbers may not exactly be reflecting reality!"

Consumers hold the key, and they aren't opening the door

To get a true picture of the extent of this train wreck, it's the consumer everyone should watch, says Pretti. "Bluntly, the greatest risk faced by the economy is a continued consumer-led retrenchment. Consumer confidence readings currently rest at lows not seen since 1980--at the same time that consumer spending drives more of GDP than at any time in history. I believe we have meaningful cause for concern."

Traditionally, consumer spending accounts for about two-thirds (66%) of US GDP. Recently, it hit a record level near 71%—making the psychological mood and behavior of household consumers an even more critical determinant of the direction of the US economy. "Higher food, energy, and general living expenses; no meaningful wage growth; it's no wonder they are morose," said Pretti. "The stark reality is that in a globalizing economy, employers can draw on an international workforce and developing economies can bid up the price of energy and food commodities."

Consumers' usual escape valves are missing, he points out. "The long overdue retrenchment in the US financial sector is imposing severely tightened credit conditions," Pretti says. "No more home equity lines of credit, option-ARM financing, 'no doc' and 'low-doc' mortgage loans. Gone are the days of freewheeling and easy credit. Massive real estate-related asset write-downs have left financial institutions with little desire to lend, so consumers have nowhere to turn for their traditional credit 'fix.'"

"Instead of wishful thinking, consumers, regulators, and particularly investors need to be aware of what's really happening," Pretti says. "We’re in the midst of a US recession that has not yet been televised-- the-not-ready-for-prime-time recession!"

Rising inflation is killing stimulus efforts

There are opportunities for profitable investments, but they must be made with one eye on the building US inflationary pressures. Bonds, once a traditional safe haven in a recession, are yet another casualty of the current economic situation. "After fleeing into good quality bonds in reaction to the US credit market crisis, investors last quarter suffered their eighth worst quarterly loss in three decades," Pretti says. "Holding US interest rates purposefully low has battered the dollar's value and increased inflationary pressures in the domestic economy. That's a killer for bond investors."

Although the Federal Reserve is more than aware of these unintended consequences, its capacity to influence future domestic economic outcomes is greatly diminished by developing nations' supply-and-demand forces, Pretti says. "Globalization changes everything."

"The Fed is in a vise. While it is trying to keep domestic interest rates low, central bankers everywhere else in the world are raising interest rates and tightening credit to forestall inflationary pressures. Higher global interest rates are further weakening the dollar, ratcheting up inflationary pressures in our import-dependent domestic economy. This is the price we're paying for our past credit mania," Pretti says.

The stock market is a good bit of a minefield, too, he says. "Investors will need to discount the reality of corporate earnings in a consumption constrained environment. Worse than the fact that June was the worst month (-10.2%) in the market since September 2002 is the fact that it wasn't even associated with one single event. Double-digit declines are rare and almost always linked with a specific economic or geopolitical event--so this is a real indicator of the magnitude of current market concern and inflationary malaise bearing down on the US economy. Looking ahead to the latter half of 2008 and early 2009, investors don’t like what they see!"

Pretti advocates remaining flexible and prepared to take action, but not necessarily jumping too fast. "Think now, but maybe act a little later," he says. "The greatest future opportunities will continue to be found in sectors levered to globalization, including energy, agriculture, water, alternative energy, foreign equities, and large global companies whose future growth lies abroad. All of these have experienced recent price declines and are where longer-term investment opportunities will eventually rise. Forget about sectors tied solely to the domestic US economy--especially if they are credit-cycle dependent."

"I'm telling investors the world is not about to come to an end," Pretti says. "But we're going to have to live through a period that is downright unpleasant. Unfortunately, it is part of a necessary process to restore the domestic economy to ultimate health."