On Friday, the Weekly Leading Index (WLI) of the Economic Cycle Research Institute (ECRI) registered negative growth for the second consecutive week, coming in at -5.7. The rate of decline from the peak in October 2009 is unprecedented since the metric was first devised in 1965.
Before we examine the WLI, let's first review the relationship between the Gross Domestic Product (GDP) and recessions since 1965. The conventional definition of a recession is two or more consecutive quarters of negative growth. The National Bureau of Economic Research (NBER), charged with establishing official recession start and end dates, doesn't follow convention in making its recession calls — often a year or more after the fact.
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A Leading Indicator for Recessions
The ECRI WLI growth metric has had a respectable record for forecasting recessions. The next chart shows the correlation between the WLI, GDP and recessions.
A significant decline in the WLI has been a leading indicator for six of the seven recessions since 1965. It lagged one recession (1981-1982) by nine weeks. The WLI did turned negative 17 times when no recession followed, but 14 of those declines were only slightly negative (-0.1 to -2.4) and most of them reversed after relatively brief periods.
Three of the false negatives were deeper declines. The Crash of 1987 took the Index negative for 68 weeks with a trough of -6.8. The Financial Crisis of 1998, which included the collapse of Long Term Capital Management, took the Index negative for 23 weeks with a trough of -4.5.
The third significant false negative came near the bottom of the bear market of 2000-2002, about nine months after the brief recession of 2001. At the time, the WLI seemed to be signaling a double-dip recession, but the economy and market accelerated in tandem in the spring of 2003, and a recession was avoided.
The Latest WLI Decline
The question, of course, is whether the latest WLI decline is a leading indicator of a recession or a false negative. Only once (following the Crash of 1987) has the indicator dropped to a level lower than the -5.7 without the onset of a recession.
Can the Fed take steps to avoid a double-dip? The next chart includes an overlay of the Federal Funds Rate.
Lowering the rate has been a primary tool for stimulating a weak economy. As the last chart shows, that tool is not available in our current situation.
We'll keep an eye on the Weekly Leading Index with regular chart updates.
Disclosure: No positions
