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The latest smoothed annualized growth rate of the ECRI Weekly Leading Indicator in the week ended 22 January improved from -7.6% to -6.5% published last week. This is the 23rd consecutive week of contraction since August last year.

Click on any chart below to enlarge:

Sources: Dismal Scientist; Plexus Asset Management.

But where is it heading? In previous articles I argued that the smoothed annualized growth rate of the WLI bottomed at -10.1% (officially adjusted from 10.2%) in the week ended October 23 last year.

In light of the significant movements in investment markets over the past week, I had a look at what growth rate can be expected of this important number that will be published at the end of this week for the period ended last Friday. To get to my forecast I use different variables that seem to explain the growth in the ECRI WLI fairly accurately. (Please note that I do not have knowledge of the proprietary ECRI WLI constituents and simulate the Index using my own research.)

The smoothed annualized growth rate of S&P 500 Index (SPX 1316.33 ↓-0.16%) remains my best indicator of the ECRI WLI growth rate.

Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.

The contraction in the S&P 500‘s smoothed annualized growth rate ended in the second week of January after contracting for 22 weeks in a row. Over the past week the growth accelerated to 2.9% from 0.4% a week ago. It is evident that the improved growth rate of the S&P 500 is likely to have exerted upward pressure on the smoothed annualized growth rate of the WLI over the past week.

Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.

The contraction in the smoothed annualized growth rate of the yield on the U.S. 10-year Government bond index recorded its 34th week of contraction and remains close to its worst levels since January 2008, at -65%. It is unlikely that U.S. bonds exerted downside pressure on the WLI growth last week.

Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.

Last week also marked the 24th consecutive week of declines in the smoothed growth rate of the Economist Metal Price Index. After slumping to -35% at the end of December last year, the rate of contraction eased to -22.4%. This easing probably eased the contraction in the growth rate of the WLI last week.

Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.

Sources: Dismal Scientist; Plexus Asset Management.

Another indicator that I value is the growth rate of initial jobless claims. Contrary to other factors that forced the contraction in the growth rate of the WLI over the past 25 weeks +, the growth rate of jobless claims indicates contraction for 35 consecutive weeks. Assuming that jobless claims were unchanged from the previous week’s 377,000, the growth rate declined to ‑14.4% from -15.1%. Initial jobless claims needed to fall to 365,000 to continue to exhibit a faster decline in growth.

Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.

I have also identified another factor that may have a major bearing on the WLI. The smoothed annualized growth rate of the yield spread between the 30-year government bond and Moody’s Baa Corporate Bond is highly correlated to the growth rate of the WLI smoothed annualized growth rate. (Please note the reverse order of the axis of the WLI in the graph below.)

Sources: Dismal Scientist; FRED; Plexus Asset Management.

Last week the yield spread entered its 24th consecutive week of positive growth but eased to 38.9% from 42.5% the previous week and is significantly below the 61.2% level reached in the first week of December last year. The lower growth rate of the yield spread is likely to alleviate further downside pressure on the WLI growth rate last week.

Sources: Dismal Scientist; FRED; Plexus Asset Management.

Another factor that some columnists advocate may influence the WLI is the MBA Mortgage Application Survey Purchase Index. Although there is some quantitative evidence of the correlation between the smoothed annualized growth rate of the Purchase Index and the WLI, it is not very helpful in forecasting the WLI, however.

Sources: Dismal Scientist; Plexus Asset Management.

M2 money supply growth is also cited as an important factor in the WLI. To my mind, the Fed’s intervention since 2008 makes it an unreliable factor in forecasting the growth rate of the WLI.

On balance, I therefore expect last week’s smoothed annualized growth rate of the ECRI WLI (to be published on Friday) will have eased significantly to approximately -4.5% from -6.5% the previous week. I think the easing of the contraction in the smoothed annualized growth rate of the WLI is set to continue in coming weeks. This is supported by further growth, especially in the S&P 500, and further easing in the contraction in growth in metal prices and a further contraction in growth in initial jobless claims. The Fed’s TWIST program may depress the WLI and the growth thereof due to artificial low long bond rates.

A very interesting aspect came to the fore when I delved into other factors that might influence the WLI. The smoothed annualized growth rate of the U.S. dollar/euro exchange rate tracks the WLI growth rate. In fact, it tends to lead the WLI at major bottoms.

Sources: Dismal Scientist; Plexus Asset Management.

Source: What To Expect From Friday's ECRI Weekly Leading Indicator