The Economic Cycle Research Institute’s Weekly Leading Index (a.k.a. ECRI WLI) is one of the most watched indicators of our economy’s future direction. Over the years, the ECRI WLI has been very accurate in predicting (or at least tracking) the health of the economy. Because of this, its movement closely mirrors, and impacts, that of the stock market.
This is troubling for two reasons:
- The latest reading, released Friday, showed that its annual growth rate fell to -9.8% this week, from -8.3% last week. It’s bad enough that the growth rate is negative (which indicates that the economy’s health is receding). The fact that it is negative AND falling adds insult to injury. It implies that the economy’s health is degrading at an accelerating rate. Worst of all, the growth rate is perilously close to -10%. In the 42-year history of the ECRI WLI, a -10% reading has been 100% accurate in predicting U.S. recessions
- I can say with great certainty that the growth rate WILL fall to -10% AND KEEP FALLING.
How can I say that with certainty? Easy...
In my recent article “Which Way Is the Market Going Next?”, I predicted that the stock market’s 50 day moving average would fall below its 200 day moving average. My reasoning was simple. By looking at the data points that are about to be removed from the moving averages, we can make a reasonably accurate prediction as to their future direction.
Similarly, we can make a reasonable prediction as to the movement of the ECRI WLI growth rate. To calculate growth rate, you take the latest data point(s) and divide it by the older one(s). You can find historical WLI readings on ECRI’s website, here. From there, all you have to do is make a reasonable assumption of what the future readings will be and do the math.
Looking at the data, you will see that the WLI experienced a massive run that stretched from early-March of 2009 through April of this year. A particular strong portion of the move occurred from July 2009 through the end of October, when the index rose from 118.2 to 129.2.
If the WLI can mount a similar rally in the coming weeks, its annual growth rate could stop falling (or even start to improve). However, that appears highly unlikely. Most economic indicators are pointing downward. This is no surprise if you consider that the inventory refresh is almost over (as evidenced by the ratio of sales to inventory), taxes are rising, stimulus is faltering, unemployment benefits are ending, home and vehicle buyer credits have expired, Europe is shifting from stimulus to austerity, and China is looking to cool its overheated property market.
Sure, Q2 earnings are looking pretty good, but that only tells us what happened in the past, between March and June. Indeed, the preponderance of current data is negative and should foster pessimism in the rational mind.
ECRI’s index has reflected this reality. In fact, the WLI has been falling precipitously since the end of April. Given the plethora of economic headwinds, the best we can reasonably hope is for the index to stop falling.
However, a mere stabilization won’t be enough, because every week the growth rate will be calculated against the bigger and bigger numbers from last year. Any number divided by increasingly larger numbers will yield increasingly negative results.
Because of this, I can only conclude that the ECRI WLI growth rate will drop below -10% and continue to plunge.
There are many indicators that I watch to determine the market’s future direction (which I have documented in my prior articles, “Which Way is the Market Going Next?”, “Follow the Money to Determine Where the Market is Going Next”, and “More Indicators to Determine Where the Market is Going Next”). The most relevant of these indicators point to continued weakness ahead. Given the close relationship between the WLI and the stock market, we have one more serious cause for concern.
I can't predict where the market will go Monday or next week, but it seems clear that stocks will see much lower levels in the months ahead.
Disclosure: I hold long and short positions in the stock market
