Ways to Win a Recession-Predicting Contest

For the last few months, and much longer for some, there has been a barrage of commentary about whether or not "we are already in a recession." The financial media have continuously polled the public to see what they think, and asked everyone who appeared on financial television. It did not matter whether the respondent had any forecasting credentials. Apparently we all want to know what anyone thinks about this important question.

Maria Bartiromo, whose interviews other journalists might well study, draws a careful line. She does not advance her own ideas and then ask the expert to agree. Instead, she draws out information. She does show enthusiasm and encourage her interview subjects. It is amazing how often she asks exactly the question we are thinking of. Bartiromo warns that the media fixation on recession could become a self-fulfilling prophecy. On the Today Show, she made this thoughtful comment:

[T]he truth is, [“Today” co-anchor] Meredith [Vieira], it doesn't matter if we’re in a recession,” Bartiromo said. “We can talk ourselves into a recession, and that seems to be what we’re doing right now and that certainly begets more weakness.

Meanwhile, a majority of economists now agree that "we are in a recession."

It Really Does not Matter

There is no light switch that makes things terrible if the economy is in a recession and acceptable if it is not. Economic data show that we are experiencing a period of economic weakness. This means lost jobs and lost profits. It is a permanent loss and painful to many. This is true whether or not the economic weakness attains status as an "official" recession. It is a range of results, not a black or white question.

The Contest

There is persistent interest about the recession question. It is a proven winner for pundit and media articles. It is as if there was a contest going on. Let us make it official. How should we determine the winner?

There are some logical steps involved in winning a contest. First, you need a definition of a recession.

Warren Buffett, esteemed by all and especially by us, says that this is a recession by any common sense definition. Maybe so, but common sense is difficult to codify.

Some embrace the rule of thumb: two quarters of negative GDP growth. This is the definition at InTrade, where those living outside of the US can trade the prediction markets legally. Since InTrade has to pay off to winners and losers, they need a specific rule with a timely resolution. The punters have the odds at 70% or so. Bespoke Investment Group and Greenback Consulting report these results. We should note that the public has been wrong on this forecast and those selling short the 2007 InTrade recession contract collected.

The official definition comes from the National Bureau of Economic Research [NBER], the accepted recession-dating authority for decades. Here are the NBER criteria, also known as the official rules for this contest by which contestants will be judged:

The committee places particular emphasis on two monthly measures of activity across the entire economy: (1) personal income less transfer payments, in real terms and (2) employment. In addition, we refer to two indicators with coverage primarily of manufacturing and goods: (3) industrial production and (4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes. We also look at monthly estimates of real GDP such as those prepared by Macroeconomic Advisers (see http://www.macroadvisers.com). Although these indicators are the most important measures considered by the NBER in developing its business cycle chronology, there is no fixed rule about which other measures contribute information to the process.

The NBER also notes the following:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

Implications for a Winning Entry

Many contest entrants have not studied the rules:

• The effects must be broad based, not emphasizing a specific sector;
• The definition is monthly, not quarterly;
• The official start of the recession will go back to the last peak of economic activity; and
• The result is not known for months -- maybe many months -- after the recession has occurred.

The last point is especially noteworthy. The study of economics involves the use of accurate data. The official data get revised as more information becomes available. This means that no one really knows the key factors for many months. It is not that economists are stupid or incompetent. They are attempting to develop data that are useful in econometric models. Recession dating is inevitably retrospective.

The dating procedure has important implications for those entering the contest.

1. Those who started forecasting the recession too far in advance should be disqualified. There has to be some statue of limitations.
2. If the current period gets defined as a recession, those "calling it" at the time of the last peak will be the winners. The official date will go back to that time -- perhaps October or November.
3. There could be a recession, as defined by the NBER, even if there is no single quarter of negative GDP growth. Careful readers will observe that all criteria could be met without an actual decline in GDP.

Handicapping the Field

The Perma-Bears. Readers can submit their nominations, but quite a number of forecasters have been on the recession theme for more than a year. They are disqualified, unless they specified a starting point.

October-November predictors. These entrants might win, if the NBER conditions are met. These are the pundits who have said for months that "we are already in a recession." A better formulation of their comments might be that these conditions, if sustained for a long enough period, will eventually be judged as a recession by the NBER.

The Deniers. There are several respected pundits who do not believe that current experience will constitute a recession. These include Rich Karlgaard, Vince Farrell, Gary D. Smith, Dick Green, Mark Perry, and David Malpass. These observers, all of whom we respect, note that current data are not actually at the levels of past recessions. We note that the NBER might deem this a recession if the pullback from the peak is great enough, broad enough, and long enough.

The Probability Analysts. Some of our most thoughtful and respected sources consider the data and make forecasts in a careful fashion. These forecasts weigh probabilities, mostly the question of whether the NBER criteria will be met. They ask the question of whether the current economic weakness will eventually prove to be long enough and broad enough to meet the definition. This group includes two of our favorite sources, including the ECRI (recently calling the recession) and Econbrowser (with an ongoing evaluation).

The Winner?

Winning the recession forecasting contest is a bit like wining one's NCAA March Madness pool. The most thoughtful handicapping may lose to those taking an eccentric but winning position.

We expect the ultimate winner to be a pundit from two polar opposite groups: one calling the start in October or November or one predicting that no recession will occur.

Our reason? If this time period is ultimately deemed to be a recession, the dating will go back to the last peak. Those are the rules.

Corrections? We invite anyone whom we have missed to check in with an entry. Readers, too. Also, please let us know if we mis-represented anyone's position.

Winners will be announced in a year or so, when the NBER analyzes all of the revised data!

Comments

[vrspace]

You mention Bartiroma and unlike some of her CNBC associates she maintains or at least appears to try and maintain an unbiased position. A great example is in her inteview April 2 with Soros -- The following is a link to the uncut version of that interview and as a side benefit provides Soros' recession prediction.

(requires windows media player and you need to past the link into your browser address bar)

plus.cnbc.com/results/[e-mail]%26key%3DORYf...

[Gross Bill]

It seems like you fell into your own trap, Jeff. Sheesh, what passes for financial journalism.

[Nate C]

Hey Vrspace--Bartiroma is a puerile simpleton who is only there because she is aesthetically pleasing and to pump stocks. She is happy when the market is up and depressed when the market is down. She tells everyone to buy buy buy. CNBC personalities are egregiously incompetent. The only good one is Rick Santelli who used to be the head of derivatives trading for Drexel Burnham Lambert at the CBOT. He does not pump data, just tells you what the markets are doing and anticipating. Because he refuses to pump stocks they only give him 30 seconds-1 min to speak. He is the only person on CNBC that I follow. I wish he had his own show instead of Cramer and Kudlow.

[MattBlackman]

In the final analysis, investors need to realize that a recession is more or less moot as far as their portfolios are concerned. By the time we realize we are in recession (hopefully long before one is confirmed by the NBER six or more months after the fact), much of the portfolio damage is already done. It's like waiting to know for sure that Bear Stearns is technically bankrupt before selling your shares.

It's the bear market that precedes the recession that should be the first and foremost concern. The indicators I follow started flashing a warning more than a year ago and as more confirmed this probability, action needed to be taken. The real melt began in late October but we had two early warnings - May 2006 and Feb 2007. The next major sign was the negative divergence between the Dow Transports and Dow Industrials (see charts in link at tradesystemguru.com/co... )

It is also important to point out that stocks can act like the economy is in recession even though one is never confirmed. For example, the recession that hit the US in 2001-2 never officially hit Canada whose GDP growth hit a low of +0.7% during that period. However, the Canadian S&P/TSX Index dropped 50.2% compared to a drop of the S&P500 of 50.5% over the same period. In other words, stocks acted as if the country was in recession even though one never officially occurred.

Matt Blackman Host www.TradeSystemGuru.co...

[caveatBettor]

How about trading the US.RECESSION.2008 contracts at Intrade?

https://intrade.com/aav2/tradi...#