One of our favorite forward looking economic indicators is the Chicago Fed National Activity Index (CFNAI). Comprised of 85 separate economic times series, this indicator predicted the Great Recession began in December 2007. That was eight months before the NBER. On the indicator’s 10th anniversary, the Chicago Fed has released a study of its ability to forecast GDP and inflation – the results are rather impressive and can be found here.
The most recent release of the CFNAI indicated economic activity continued to accelerate and Q1 GDP would be relative robust. We find this indicator so powerful that it is almost enough to change our decidedly cautious stance on U.S. equities.
BUT the ultimate judge is the market and investor reaction to news – the reaction this earnings season has been less than enthusiastic. Companies have beat on the bottom line, matched on revenues and have still been sold off. Almost exclusively the reason for the earnings related weakness is the outlook for the second half of 2010.
The most recent victims are Radio Shack (RSH) and Nordstrom (JWN) – both companies posted respectable earnings, but warned of a slowdown in the second half of the year. These negative second half forecasts are in contrast to the conventional economic wisdom that the yet to be enacted stimulus programs will kick in and complete the hand-off from government spending to private consumption.
The second half concerns are consistent with our view of significant economic headwinds as a result of household de-leveraging. We view the financial crisis as the end of multi-decade credit expansion cycle which began after World War II. This will be the first time since Great Depression the U.S. economy has emerged from recession without the economic tailwind of credit expansion.
In light of this view, and despite the CFNAI robust forecast, we remain cautious on U.S. equities especially as the pages of the calendar disappear.
Disclosure: Long SDS, Short JWN