Why the ECRI Is a Good Economic Indicator

Investors need advance economic warning on the economy. There is only one game in town – that is Economic Cycle Research Institute (ECRI) Weekly Leading Indicator (WLI). I publish this index weekly.

Now Mish Shedlock says the WLI is not worth anything. Krugman jumped on board. ECRI responded. Finally, Ritholtz put in his two cents.

Krugman sets up the battlefield…..

Michael Shedlock has an awesome takedown of ECRI’s claim that its indicators (a) have successfully predicted turning points in the past (b) point to a sold recovery now. I’d add that this is a really, really bad time to be relying on conventional indicators.

Why? Basically, because in a zero-interest rate world — the three-month rate was .066% last I looked — especially one that’s suffered from a collapse of the shadow banking system, conventional indicators don’t mean what they usually mean. Increases in the monetary base aren’t especially expansionary. The yield curve more or less has to slope up, even if no recovery is expected. And so on.

So historical correlations, to the extent that they exist — and as Shedlock points out, ECRI is claiming a much better record than it really has — can’t be counted on to prevail. There’s really no alternative to making fundamental analyses of the macro situation.

Ritholtz judgment….

As we have tirelessly pointed out, there is no indicator that is failsafe. Things that work on occasion sometimes stop working.

I have found ECRI to be of value to me in my own investing and trading. That does not mean they are flawless or a guarantee — just that they have had value to me.

While Mish and Lakshman debate their respective track records — Mish is correct in noting that ECRI wasn’t aggressive enough in predicting this recession, and ECRI could point out that MISH failed to see the recovery (or at least the 60+% market rally).

Traders and Investors should always be looking for the most interesting lesson to be gleaned. In this case, it comes from the Nobel laurelate: There are times when conditions vary so much from prior circumstances that usual metrics are no longer reliable.

As you know I am a fan of ECRI. They, along with other factors, gave me plenty of to get out of the market before the big bang. The argument over the beginning date of the recession of December 2007 is an arbitrary point for investors. The crap did not begin to hit the fan until May 2009 for the markets – and there is little dispute ECRI was warning strongly by that point.

ECRI’s data also convinced me to get back in testing the water in March 2009. Did they make a bad call at that point? Hey, it’s all about investing.

I could go through the truths, half truths, and misrepresentations by Mish, Krugman, and ECRI. But it is a waste of my productive time (I am spending today readjusting my portfolio).

My news flash is ECRI is really the only game in town. The Conference Board’s LEI is compromised at best. Even if ECRI’s WLI is inaccurate, you would not throw out their opinion, but you would modify them mentally to match what you believe you are seeing.

I will use one of Mish’s graphs to make a point.

ECRI claims to predict economic turning points. In my opinion, they have a pretty good forecasting record for investors.

Krugman offered no forecasting alternative – only that we make fundamental analysis. On what basis? Guesses?

As Mish seemed to have a pile of ECRI materials, it seems to me he is also paying money for ECRI’s opinion. Ritholtz admits he uses the ECRI data.

As an investor, I will let the economists stand in a circle and do what they do best.

What do economists do best?

Hat tip to Steve at MEMETICS & MARKETING™ for editing support.

Disclosures: None

Comments

[Roger Knights:]

Typo: "The crap did not begin to hit the fan until May 2009 for the markets"

Make that 2008.

Oct 15 05:43 AM

[Owen B:]

I generally agree with what you've written, with one important nuance. As I focus in on the run up to the start of the recession, ECRI was clearly pointing out the recession risk, but they were going on to make a delicate point about how cycles work -- not necessarily for us investors -- but seemingly for policy makers. (Delicate points don't do well on blogs I'm afraid.) The point being that there was a brief opportunity to create a manufacturing "short-squeeze" that would have forestalled (not prevented) the recession. This is important because once the recession took hold on top of the housing/credit mess, we would be/were in for a more nasty ride down than if policy was in a better position to handle the expanding credit crunch. If you know anything about ECRI, and clearly you do, they do not believe recessions can be avoided. I got most of this from a Jan. 2008 post from ECRI: kirklindstrom.blogspot...

Oct 15 07:56 AM

[John Lounsbury:]

(Note: This comment is copied from the Instablog of this article.)

Steve - - -

I have followed this debate with interest. Thanks for bringing it all together. I have questions about how much to believe the table pounding Laksham has done recently on the strength of the year over year change in WLI (the growth rate, which is the usual chart circulated in the world of non-subscribers). I have no doubt that WLI is showing historic growth. But it is coming from very low levels. For this reason, I have to give Barry Rithotz a nod for giving some credence to Krugman's questions.

And, of course, Mish had some good points also, in a very civil manner. Your chart, from Mish's article, does indeed say it all. Any good chart reader looking at this who did not leave the S&P 500 just below 1400 in early March, 2008 should turn in his chart reading certificate.

Good job, referee. And you were refereeing the battle over the only game in town.

Oct 15 09:27 AM

[Kirk Lindstrom:]

"I have no doubt that WLI is showing historic growth. But it is coming from very low levels."

WLI growth rate was more than telling. One of my older charts is here

forbestadvice.com/Mone...

I'll try and update that with a more current chart later today, maybe with the market price on the chart. Key point is the WLI growth has SURGED way, way above the old highs.

You can see it had already fallen off a cliff by Jan 2008. I used its decline to lower my allocation to equities several months earlier AND I used its bottoming in Dec 08 and higher low in March 09 to increase allocation to equities.

NO INDICATOR is perfect, but WLI growth seems to provide useful clues.

Oct 15 10:35 AM

[Jason Rines...:]

Nice comment John and salient. Mish must get a lot of credit for two years working his butt off to provide analysis. He is doing a bit better financial now with ads running on the site but few realize how challenging it is for a guy like Mish to put his family second and the American public first.

Thank you Michael Shedlock. While I am at it, thank you John Lounsbury and Steven Hansen. Class acts, one and all!

Oct 15 03:42 PM

[Steven Hansen:]

Roger,
thanks....typo should have read May 2008.

Oct 15 06:59 PM

[Wildebeest:]

As per instablog comment:

The chart you have included clearly shows the ECRI WLI to be a coincident indicator at best, and on occasions a lagging indicator -- of the S&P at least. Therefore you can't draw anymore meaningful information from the ECRI WLI than you could from the S&P 500. (qualifier: for this data set dating back to early 01)

Normally your articles are packed with data, and informative, here there is no data to support the title of the article.

Q1. Is the ECRI WLI a leading indicator for the S&P 500?

A1. Data set provided shows it isn't. It is coincident mostly but sometimes lagging. i.e the chart doesn't support the thrust of the article.

Q2. Is the ECRI WLI a leading indicator for the economy?

A2. Who knows. The chart I'd like to see is the ECRI WLI overlaying quarterly changes in GDP. That way we can see if it is a leading indicator of how the economy is travelling.

Oct 16 08:33 AM

[Owen B:]

A1 = I've always looked at the WLI as something to confirm cyclical moves in stocks, and that is worth a lot to me.

A2 = look at the link of a WLI vs. GDP chart that Kirk provided two comments above yours :-).

On Oct 16 08:33 AM Wildebeest wrote:

> As per instablog comment:
>
> The chart you have included clearly shows the ECRI WLI to be a coincident
> indicator at best, and on occasions a lagging indicator -- of the
> S&P at least. Therefore you can't draw anymore meaningful information
> from the ECRI WLI than you could from the S&P 500. (qualifier:
> for this data set dating back to early 01)
>
> Normally your articles are packed with data, and informative, here
> there is no data to support the title of the article.
>
> Q1. Is the ECRI WLI a leading indicator for the S&P 500?
>
> A1. Data set provided shows it isn't. It is coincident mostly but
> sometimes lagging. i.e the chart doesn't support the thrust of the
> article.
>
> Q2. Is the ECRI WLI a leading indicator for the economy?
>
> A2. Who knows. The chart I'd like to see is the ECRI WLI overlaying
> quarterly changes in GDP. That way we can see if it is a leading
> indicator of how the economy is travelling.

Oct 16 11:04 AM

[Wildebeest:]

On Oct 16 11:04 AM Owen B wrote:

> A1 = I've always looked at the WLI as something to confirm cyclical
> moves in stocks, and that is worth a lot to me.

That seems dangerous given that the WLI apparently includes market data. Depending on the weighting given to the market data in the WLI determination your confirmation could end up being circular.


>
> A2 = look at the link of a WLI vs. GDP chart that Kirk provided two
> comments above yours :-).

yes, went there after posting my comment. Actually when you think about it, the question I asked was irrelevant. Given that the WLI and S&P 500 are coincident we may as well frame the discussion about whether the S&P is a leading indicator of economy.

Oct 16 12:10 PM

[Owen B:]

> A1 = I've always looked at the WLI as something to confirm cyclical
> moves in stocks, and that is worth a lot to me.

>That seems dangerous given that the WLI apparently includes market data. Depending on the weighting given to the market data in the WLI determination your confirmation could end up being circular.

Not really as the WLI is not only stocks but also other unrelated indicators, i.e., confirming... and agreed, not leading the market at all.


On Oct 16 12:10 PM Wildebeest wrote:

> On Oct 16 11:04 AM Owen B wrote:

Oct 19 10:52 PM

[Wildebeest:]

yeah sure but the keyword was "weighting", eg. if it was 10% market and 90% non-market then I'd agree with you.


Do we know what the various weightings are?? I've not seen that sort of quantitative stuff mentioned any any discussions about the ECRI (but admittedly have not conducted an exhaustive search)


On Oct 19 10:52 PM Owen B wrote:

> > A1 = I've always looked at the WLI as something to confirm cyclical

Oct 20 01:09 PM