WLI Rises To 32-Week High; ECRI Expects More Frequent Recessions

|
 |  Includes: BRK.A, BRK.B, SPY, TIP
by: Kirk Lindstrom

The Economic Cycle Research Institute (ECRI) - a New York-based independent forecasting group - released its latest readings for its proprietary Weekly Leading Index (WLI) today.

For the week ending March 16, 2012:

  • WLI is 125.7, up 0.7 from the prior week's revised reading of 125.0.
  • The lowest reading for WLI on record was 105.3 for the week ending March 6, 2009.
  • WLI growth rose to negative 0.4%, up from last week's reading of negative 1.4%.
  • The lowest reading for WLI growth on record was -29.9% on December 5, 2008. It turned higher months before the stock market [S&P 500 (NYSEARCA:SPY)] bottomed on March 6, 2009, at 666.79.

WLI made a 32-week high. It has not been this high since August 5, 2011, when it was 128.5.

WLI growth made a 31-week high. It has not been this high since August 12, 2011, when it was a positive 1.0.
Click to enlarge
(Click to enlarge)

Yesterday, ECRI's Co-Founder and Chief Operations Officer, Lakshman Achuthan, gave a presentation at the Bloomberg Sovereign Debt Conference today in Frankfurt, Germany explaining why recessions will be more frequent.

The convergence of two cyclical patterns virtually dictates an era of more frequent recessions in developed economies. As a result, growth in developing economies is going to be jerked around more than people think, making for a good deal of cyclical economic contagion. In other words, we are now in the yo-yo years.

Their concluding warning was:

This warns against a complacent buy-and-hold mentality. In fact, the world is a much more dangerous place than many appreciate, but there are still going to be opportunities for investors, as long as they consider the timing of cyclical risk.

Last week in an article "Why ECRI Stands By Their Recession Call" ECRI explained why it remains bearish on the US economy and continue to predict a recession.

Two weeks ago Achuthan said a recession should begin by mid-year 2012. He says revisions in the data might say a recession has already started, just like the last recession. If the recession is starting now, then the consensus should figure it out in about six months (August.)

Chart of WLI and WLI growth vs. GDP Growth
Click to enlarge
(Click to enlarge)

Since ECRI releases WLI numbers for the prior week, and the stock market is known in real time, you can sometimes get a clue for next week's WLI from the weekly change in the S&P 500 or its exchange traded fund, SPY. Notably, in the lead-up to the last two recessions, the WLI turned down months before the stock market did.

Chart of S&P500 vs. ECRI's WLI
Click to enlarge
(Click to enlarge)

IS ECRI WRONG?

Does their model take into account the "presidential election cycle" where the sitting president will spend all he (or she) can to prevent a recession? Remember most one-term U.S. presidents did not get a second term because they forgot "It's the economy, stupid." Has the combined effects of central banks running printing presses at maximum speed combined with fiscal stimulus from payroll tax cuts in the U.S. mixed with unsustainable deficit spending overwhelmed the business cycle or merly delayed the inevitable?

Note that the chart above of the S&P 500 vs. WLI shows a breakout of the S&P500 above the dashed blue line that represents the neckline for a "Head and Shoulders Bottom" pattern. This is a very bullish pattern. A pullback to this neckline during a global slowdown projected by ECRI would not invalidate the bullishness of this pattern but it appears we already had a test of this support line from above last year and the market has moved on to new highs not see since early 2008.

I continue to believe caution is in order. I continue to take profits in equities as the market rises so my "explore portfolio" is now and up 10% YTD with "only" 2/3rds in equities and 1/3 in fixed income earning next to nothing this year. The higher return than expected for this allocation comes from taking advantage of the "investment opportunities" ECRI talks about as well as extra alpha from individual stock selection.

Heading ECRI's warnings and following the footsteps of Warren Buffett, CEO of Berkshire Hathaway Inc. (NYSE:BRK.B), I think it is never wise to be "all in" the stock market with no cash cushion to buy corrections and bear markets. Likewise, anyone "all in" fixed income is probably losing to inflation unless all in TIPS (NYSEARCA:TIP).

Buffett's Berkshire Hathaway Inc. (Class A Shares BRK.A, ended 2011 with $37.3 billion in cash on hand (link), which is 19% of its current $201 billion market cap.

Notes:

  1. Occasionally the WLI level and growth rate can move in different directions, because the latter is derived from a four-week moving average.
  2. ECRI uses the WLI level and WLI growth rate to HELP predict turns in the business cycle and growth rate cycle respectively. Those target cycles are not the same as GDP level or growth, but rather a set of coincident indicators (including production, employment income and sales) that make up the coincident index. Based on two additional decades of data not available to the general public, there are a couple of occasions (in 1951 and 1966) when WLI growth fell well below negative ten, but no recessions resulted (although there were clear growth slowdowns).
  3. For a better understanding of ECRI's indicators, read its book, "Beating the Business Cycle."
  4. SPY is the exchange traded fund for the S&P 500 Index.

Disclosure: I am long SPY.