Why the Recession Is Over

It's deep summer at last, and that means lower trading volume and an easier time manipulating the market for those so inclined. The reasons given for the recent weakness – worries about the timing and pace of the economic recovery – didn't make sense to me. I wrote about the lagging indicators on June 15 and said don't let the laggers and those who quote them fool you, the recession is over. Now I've taken a look at the leading indicators, as you'll see below, the story is the same:

The recession is over.

So either there is something new going on that will push the stock market much lower, or this was just one more consolidation and set-up for another big push up as more investors reluctantly realize the recession ended in June.

The Leading Indicators

The Conference Board calculates the leading indicators, as well as the coincident and lagging indicators. They spent millions of dollars and thousands of hours of economists' and statisticians' time developing these indicators. On June 18 they released the indicators as of the end of May. You have to love the Yahoo posters who start out: “The stock market predicts nothing.” It's so easy to have a strong opinion when you don't have to bother doing the hard work to actually deduce something from the data. It is investors like that commentator that will provide the fuel for the next upleg, or perhaps the one after that.

Of course, statistical analysis shows that the stock market not only is one of the leading indicators, it is the one with the best record of calling economic turns. The 10 components of the leading indicator index are:

1. Supplier deliveries (vendor performance) – up in May
2. The interest rate spread (long rates minus short rates) – up in May
3. Stock prices – up in May
4. Real money supply, adjusted for consumer inflation – up in May
5. Index of consumer expectations – up quite a bit in May
6. Building permits – up in May
7. Manufacturers' new orders for nondefense capital goods – up in May
8. Average weekly manufacturing hours – down in May
9. Average weekly initial claims for unemployment insurance (inverted) – down in May as claims rose
10. Manufacturers' new orders for consumer goods and materials – down in May

Obviously, some of the components turn up before others, and some turn up, then go back down, then turn up again. The Conference Board formula weights all these based on their historical accuracy. When there are seven components up and three down, as in May, the diffusion index is 70%. Even when things are really rolling, the diffusion index rarely gets above 80%. Two of the four components of the coincident indicator index were up, and two down. All seven of the lagging indicators were down in May.

As the following chart shows, the leading indicators turned down well before the recession started and the coincident indicators turned down afterwards, as expected:

click to enlarge

With the coincident indicators falling at a slower rate and the leading indicators sharply up, I believe the National Bureau of Economic Research, whose job it is to date the beginning and ending of downturns, will say the recession ended in June 2009. The June data release is scheduled for July 20, and we will revisit this chart then.

The “Leadingest” Indicator

So, if the stock market is the best leading indicator of the economy, wouldn't it be handy to have a leading indicator that leads the stock market? Yes, indeed, and we have one. It is the ratio of the leading indicators to the coincident indicators. As an economic upturn matures, the leading indicators start to flatten while the coincident indicators are still rising rapidly, so the ratio of the leaders to the coincidents starts to fall sharply even before the leading indicators index or the stock market itself show any weakness. As the recession nears, the leaders begin to fall while the coincidents are still rising, and the ratio plummets in a clear sign that the end of the good times is nigh. But as the recession progresses, there comes a point when the leaders simply fall slower while the coincidents are dropping rapidly, so the ratio bottoms and begins to climb. Then the leaders accelerate as the end of the recession comes into view, but the coincidents are still declining (if slowly) and the ratio continues to climb. That's where we are now:

As you can see, you can also look at the ratio of leaders to laggers or the one the Conference Board publishes, the ratio of coincidents to laggers. I look at them all plus the underlying numbers for each series to try to get a sense of where we really are, which direction we appear to be going, and how quickly or slowly things are changing. Taken collectively, these are a very good substitute for a full-time economist, and the raw information is free at Conference-Board.org.

The recession is over.

I use fractal analysis to understand where the market is in its cycling back and forth between trending and consolidating. An extended consolidation like the one since May 8 is very unusual, but not unprecedented. Normally, when it comes to an end the previous trend resumes with a vengeance, but not always. It could be the lack of a second upleg is warning us that the whole rally is over.

But that is the lowest probability outcome. It is much more likely that the uptrend will resume, now with plenty of energy to stun the bears and the underinvested by a quick move up to 1060 on the S&P 500. That can happen just from the stored energy in the market, regardless of the economic news.

To get past 1060 and up to 1160, or even 1250, we will need good economic news. I know you are still hearing outright bears saying the economy is much weaker than the market rally is saying. As I wrote in that June 15 SeekingAlpha article, they almost always cite more foreclosures and weak employment, both of which are lagging indicators this time around. The mainstream opinion seems to have shifted to: “Well, there may be a second half recovery, so we can start nibbling, but we have to be cautious and keep our powder dry in case the market corrects this rally by retracing 50% of it.” A bearish variant is to say: “Sure, the Obama stimulus is going to make the second half look good, but then we'll go back in the soup in a double-dip recession.”

All of them are wrong. It is more and more clear that a new bull market began on March 8, and my call that the recession ended in June was accurate. The Weekly Leading Indicator index (WLI) of the Economic Cycle Research Institute has been very accurate:

At the end of June, the WLI turned positive year-over-year, and the ECRI said: “Following a 28-week upturn, WLI growth has broken into positive territory for the first time in over 22 months -- an affirmation that an end to the recession is at hand.”

Last week they were quoted as saying: “"We'll definitely see the end of this recession this summer. As unique and unprecedented as this recession has been, the transition to recovery is showing up in a textbook way in the leading indicator charts.”

So not only is the S&P likely to start a major upswing to 1060 just based on stored-up energy (money on the sidelines or short), but I think we also will get the near-term economic news we need to propel it all the way to 1160, and possibly 1250. That is a huge move, and will go a long way towards repairing your retirement portfolio.

The recession is over.

Disclosure: No index or index option positions.

Comments

[TeresaE:]

I so want to slam this and call you an idiot.

But, knowing human nature and the entirely normal human backlash against being called names, I will hold myself in check.

Manufacturing orders were "up" in May because GM (and Lear and fill in the blank of next bankruptcy in manufacturing) ramped up their suppliers knowing FULL well the suppliers would never be paid and stuck with the bill.

And more than likely many of these suppliers will file bankruptcy soon. Many bankruptcies, both business and personal, as us small business owners actually put our money where our mouth's are. (as compared to your buds who are only risking other people's money, they get paid rather they fail or not--kind of like you).

Let's just call a duck, a duck.

Our entire economy was "successful" based on two things: liar loans and profits from off shoring our middle class jobs.

Both those things are gone. Now what?

And, btw, in case you just arrived in this position and have no access to year over year data going back further than last year, May is ALWAYS up in real estate and factories. Gearing up for the 3 month vacation our brains are conditioned for. The market was up because the Fed is now allowing the banks to cook their books legally.

Can't wait to see your spin on July's numbers. Which if my company, or my customers/suppliers, are any indication, will knock your green socks off!

Champagne for all, the recession is over!

Oh wait, better make that Night Train, the depression train has been idling at the station for a lonngggg time.

Prognosticators like you better hope food riots and a French styled revolution isn't in the cards. With analysis like this you will be on the top of many peoples' lists for offing of the head.

Jul 08 09:46 AM

[MartyT:]

Mr. Murphy,

Thanks for the post it takes a lot of courage to make a post like that during times like these.

I have no idea if we've bottomed out or not, but I've noticed that the bottom occurs when pessimism is at its highest. I think the fact that your post was met with overwhelming negativity is a clear indicator that pessimism is at a high point.

My guess is that we are either teetering on the edge a total collapse of several of our systems or that you are correct and we are at the bottom. Assuming that we are at the bottom we may have a long, slow, painful climb up.

Thanks again...

Marty

Jul 08 10:01 AM

[Alphameister:]

Unfortunately, the "eye of a hurrican" metaphor seems all too plausible. One of the most disconcerting things I noted in connection with this post was that the latest two-month performance of the LEI was the best since Nov/Dec 2001. OUCH! Even if the economy hits bottom in the short run, I can't envision a recovery that would sustain a strong advance by US stocks.

Jul 08 11:32 AM

[Michael Murphy:]

Sadly, the Obama regime is unlikely to pay me anything, since I have repeatedly written that they are acting like idiots, and I have a book coming out with Bernanke's picture on a dollar bill next to the sad chart of the value of a dollar since the Fed was created.

"I feel your pain" as another lousy President said (quite a string of them lately). But please, for your own financial well-being, consider these points:

1. Bernanke et al are flooding the economy with so much money and credit that a big inflation, maybe a hyperinflation if he loses complete control, are inevitable. In that scenario, stocks go up dramatically as people trade depreciating dollars for anything. That money is starting to hit right now.

2. The ECRI has been accurate so often for so long that I guess I have gotten in the habit of believing them. Geoffery Moore, who started it, is the god of statisticians. They are POUNDING THE TABLE that the recession is over. Now, you may be a better statistician than ECRI or have a better model, but if you are not, go to their website and figure out exactly where they are wrong. Don't dismiss them out of hand because it "feels" wrong to you, or your results will be as bad as the average Yahoo message board bozo. that isn't what Seeking Alpha is all about.

3. Remember that the month after the bottom of a recession is almost as bad as the worst month, and the month after that is only a little bit better. No one is going to feel good until months after the bottom.

I've been doing this for 39 years. In 1970 is was different this time because Penn Central went bankrupt, and the government had to bail them out. I go to cash when I see a top and go on margin when I see a bottom. I am on margin. I am not always right. If the LEI and the WLI stall out and turn down, I have my sneakers laced.

But for those who are short - get ready for this - if you see an upturn start midday tomorrow or on Monday, there is a two-month cycle about to hit hard. Even if you don't believe me, cover at least half your shorts and watch what happens. You can always reshort later.

PS Ferdinand E. Banks for Secretary of State

Jul 08 03:38 PM

[Michael Murphy:]

For more details, you can download my Las Vegas Money Show presentation on the coming (hyper)inflation at NewWorldInvestor.com/m....

Or call me an idiot to my face ( no offense taken) at the Money Show in San Francisco on August 22 and 23.

You also can follow me on Twitter at twitter.com/newworldin... for brief updates.

Jul 08 03:53 PM

[nova:]

Michael Murphy wrote:
"1. Bernanke et al are flooding the economy with so much money and credit that a big inflation, maybe a hyperinflation if he loses complete control, are inevitable.
In that scenario, stocks go up dramatically as people trade depreciating dollars for anything. That money is starting to hit right now."
This is what I was also thinking about. This makes sense.

There is another issue: with all this cash, Chinese and Japanese can buy all US companies having any value and most naturel resources suppliers. Yes, Obama regime will not allow this to happen. As a result, a new all-out trade war is in cards.

The bottom line
Obama regime is very dogmatic, ideological and outright incompetent.

Jul 08 04:35 PM

[ebor:]

Someone else agrees with you too:
www.dailykos.com/story...
It's hard to trust numbers over emotion and sentiment, but you're right that the indicators are clear.

Jul 08 04:52 PM

[swaps:]

This is truly a courageous post.
At the same time I am now embarrassed to be Irish.
This posting must prove the dictum that if your neighbor loses his job it's a recession. If you lose your job it's a depression.
I can only intuit that hardly anyone has lost jobs in Mr. Murphy's affluent upscale neighborhood.
However, I will concede that my working class - sometime student younger daughter, unemployed since December, has been hired. But she lives in Boulder, Colorado, which Forbes magazine has identified as a safer harbor for rebound. However, her wage is 40 percent less in retail than it was before in upscale manufacturing.
.If Mr. Murphy is correct, my older daughter will complete her three year, double degree Master's program next May, well after the economic recovery starts creating a rising tide of lucrative jobs and raising the need to import cheap foreign labor to deflate wage inflation again.

Jul 08 07:36 PM

[Gregman2:]

Let's just chalk this entire post up to...an early morning sniff of ye olde crack pipe.;-) Way to go, Mike!

Jul 08 08:14 PM

[perceptions...:]

I 've got a buck says there will be more slight rises, amid a falling trend, like those in the graph in the following link.

www.planbeconomics.com.../

Jul 09 01:22 AM

[Michael Murphy:]

ebor - Thanks for the dailykos link - at least there are two of us.....

swaps - Unemployment is a lagging indicator, and this is likely to be a jobless recovery. So watching unemployment for a sign to get back into the market means you will miss most of the first double off the lows.

I have two kids in the workforce, one lost his job and is still unemployed, the other quit two jobs to go to law school on her savings. To quote the dailykos article: "Let me add one more point: I am not saying it's wonderful that people are out of work, or that we shouldn't increase the length of time people are on unemployment insurance or anything remotely or even non-remotely related to that."

I'm just saying the recession is over, the worst is behind us, the S&P 500 is short-term oversold and headed for 1060, and if three or four more people start telling the big institutions the recession is over, it will go to 1160 and maybe 1250.

Jul 09 04:36 AM

[kebu77:]

As the X-Files poster says, "I want to believe."

But there are odd data points this time around that give pause. Just one, relating to new home sales (see chart in Daily Kos story about new home sales maybe reaching a bottom) - - For two years now, new home completions have exceeded new home starts/permits by over two million homes.

As completions have fallen month-by month, starts/permits have fallen as well (the last month as I recall was a gap of around 245,000 homes and completions still far exceeded actual sales). In many markets builders would have to stop building entirely and only then would inventories stop growing several months later.

And don't get me started on the existing home situation...

Jul 09 12:43 PM

[gjr48:]

Consumer spending makes up 70% of our economy. Approximately 25% of that 70% is healthcare related. The American healthcare 'system' is broken but we do not have the political guts to address this matter.

We need to get our heads out of the sand and learn from how the other industrial nations are handling this matter and thereby helping both their consumers and their businesses.

On Jul 07 04:55 PM MarcVdB wrote:

> It is striking that in assessing the state of the economy the author
> fails to mention the driving force of the US economy: The consumer.
> And what does the consumer do? He is paying off his debts.
>
> There you have it. Recovery? Hardly. Restocking? Sure.

Jul 09 02:44 PM

[gjr48:]

Your list includes the 'critical' item of consumer spending ... which makes up about 70% of our economy. 25% of that 70% is comprised of healthcare related spending.

Our country needs to get its collective head out of the sand and deal with this matter as other industrial nations of the world have ... which would help both the consumer and businesses.

On Jul 07 06:15 PM conceptwizard wrote:

> Nice Post, interesting angle.
>
> So I guess we just have to close our eyes to:
>
> 1. Unemloyment numbers exploding.
> 2 Hourly weekly manufacturing hours lowest in decades.
> 3. Business investment down 35% in 2009.
> 4. Automotive sales down 7 million units.
> 5. Housing still has 10-15% to drop to the median.
> 6. US exports at alltime lows.
> 7. The Baltic Index collapsing again.
> 8. Forclosures accelerating again with Alt A, Prime, HELOC
> 9. Commericial Real Estate at 15% vacantcy rate.
> 10. California on the rocks which represents a big portion of GDP.
>
> 11. Delinquentcy rates on credit cards and loans accelerating.<br/&g...
> 47 States cant balance their budget in 2009.
> 13. Mortgage rates are creeping higher.
> 14. BRIC are downsizing US treasuries exposures.
> 15. Banks decreased credit card lending by 38%.
> 16 Banks wont mortgage Jumbo loans. (Or anything else)
> 17. Retail sales are down.
> 18. Markets are being manipulated by liquidity injections.
> 19. Bankruptcies are up 50% YOY.
> 20. Consumer spending continues to decrease. (Critical)
> 21. Oil prices are soaring, putting pressure on the consumer.
> 22. Tax revenues are down 28% in April.
> 23. Benanke is having trouble rolling 1.2 trillion in debt in 2009.
>
> 24. Social Security and Medicare are underfunded by 50 Trillion.
>
> 25. 200 trillion in derivitives exposure in US, 500 trillion worlwide.
>
>
> I have to live in the real world with the real people. How could
> have the recession have ended in June? When the numbers in the first
> week of July are still very negative. I guess I have to see/feel
> it to believe it. In a simple mans world I would like to see any
> 10 things on my list turn around.

Jul 09 02:53 PM

[yousaidwhat:]

Amen to that! I have been observing for over 10 years now that whatever the majority thinks is going to happen, never happens! In fact, more often it's just the opposite! The Y2K Scare was a classic example. The overwhelming negative response on this article is very encouraging to me. It tells me Mike is likely on the right track "The recession is over."

On Jul 08 10:01 AM MartyT wrote:

> Mr. Murphy,
>
> Thanks for the post it takes a lot of courage to make a post like
> that during times like these.
>
> I have no idea if we've bottomed out or not, but I've noticed that
> the bottom occurs when pessimism is at its highest. I think the fact
> that your post was met with overwhelming negativity is a clear indicator
> that pessimism is at a high point.
>
> My guess is that we are either teetering on the edge a total collapse
> of several of our systems or that you are correct and we are at the
> bottom. Assuming that we are at the bottom we may have a long, slow,
> painful climb up.
>
> Thanks again...
>
> Marty

Jul 09 06:15 PM

[polar40:]

Recession, depression, Inflation and hyperinflation.
The only way we can come out of all the debt is by devaluation of the dollar. China, which kept its currency at mandated low exchange rate to steal american jobs and build up a reserve by flooding WallMart/world with cheap goods will cry foul. Home values will increase, people will soon demand higher wages and the cycle will start. Prepare for higher prices.

Jul 09 08:15 PM

[Michael Murphy:]

1. The International Monetary Fund has revised up growth forecasts in the second half of 2009 and into 2010.
2. The latest reading on the Weekly Leading Index from the ECRI came in at a 5.4% growth rate, so the economic recovery is accelerating. This is a 2-year high in the growth rate for the WLI. The Managing Director at ECRI: "It is increasingly evident that, despite widespread misgivings based on backward-looking economic data, the end of recession is at hand."
3. jhartz: If you are wrong in your assessment, how many future business successes believing your thinking will shut down just as the economy turns up?

Jul 14 03:29 PM

[Michael Murphy:]

The latest reading on the Weekly Leading Index from the ECRI (7/17) came in at a 7.0% growth rate, so the economic recovery continues to accelerate. This is a FIVE-year high in the growth rate for the WLI. The Managing Director at ECRI: "The recession is already ending. With WLI growth surging to a five-year high, the recession's days are numbered, and the coming recovery is looking more resilient. The bulk of the government spending is still in front of us. The current stimulus may reinforce the recovery many quarters from now, but it's not the reason you're having a recovery."

Jul 18 03:04 AM

[JC:]

MM pumped Telkonet (TKO) to $15, its at 10 cents now but at least Steny Hoyer (D) MD was able to sell into the pump. What are friends for?


On Jul 08 03:38 PM Michael Murphy wrote:

> Sadly, the Obama regime is unlikely to pay me anything, since I have
> repeatedly written that they are acting like idiots, and I have a
> book coming out with Bernanke's picture on a dollar bill next to
> the sad chart of the value of a dollar since the Fed was created.
>
>
> "I feel your pain" as another lousy President said (quite a string
> of them lately). But please, for your own financial well-being,
> consider these points:
>
> 1. Bernanke et al are flooding the economy with so much money and
> credit that a big inflation, maybe a hyperinflation if he loses complete
> control, are inevitable. In that scenario, stocks go up dramatically
> as people trade depreciating dollars for anything. That money is
> starting to hit right now.
>
> 2. The ECRI has been accurate so often for so long that I guess I
> have gotten in the habit of believing them. Geoffery Moore, who
> started it, is the god of statisticians. They are POUNDING THE TABLE
> that the recession is over. Now, you may be a better statistician
> than ECRI or have a better model, but if you are not, go to their
> website and figure out exactly where they are wrong. Don't dismiss
> them out of hand because it "feels" wrong to you, or your results
> will be as bad as the average Yahoo message board bozo. that isn't
> what Seeking Alpha is all about.
>
> 3. Remember that the month after the bottom of a recession is almost
> as bad as the worst month, and the month after that is only a little
> bit better. No one is going to feel good until months after the
> bottom.
>
> I've been doing this for 39 years. In 1970 is was different this
> time because Penn Central went bankrupt, and the government had to
> bail them out. I go to cash when I see a top and go on margin when
> I see a bottom. I am on margin. I am not always right. If the
> LEI and the WLI stall out and turn down, I have my sneakers laced.
>
>
> But for those who are short - get ready for this - if you see an
> upturn start midday tomorrow or on Monday, there is a two-month cycle
> about to hit hard. Even if you don't believe me, cover at least
> half your shorts and watch what happens. You can always reshort
> later.
>
> PS Ferdinand E. Banks for Secretary of State

Jul 26 07:05 PM

[clawmann:]

IMF AGREES:

Global recession is over but leaves 'deep scars': IMF's top economist
www.marketwatch.com/st...

Aug 18 12:49 PM