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