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Steven Hansen (A.K.A "The Hand") was born, raised and educated in California. Steven worked for 25 years for a major international engineering and construction corporation. He has lived outside of the USA almost continuously since 1978. Steven retired in 1995 to sail the world. He is... More
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  • If All Leading Indicators are Wrong…….  8 comments
    Oct 14, 2009 11:20 PM

    Investors need advance economic warning on the economy.  There is only one game in town – that is Economic Cycle Research Institute (ECRI) Weekly Leading Indicator (WLI). I publish this index weekly.


    Now Mish Shedlock says the WLI is not worth a shit.  Krugman jumped on board.  ECRI responded.  Finally, Ritholtz put in his two cents.


    Krugman sets up the battlefield…..


    Michael Shedlock has an awesome takedown of ECRI’s claim that its indicators (a) have successfully predicted turning points in the past (b) point to a sold recovery now. I’d add that this is a really, really bad time to be relying on conventional indicators.

    Why? Basically, because in a zero-interest rate world — the three-month rate was .066% last I looked — especially one that’s suffered from a collapse of the shadow banking system, conventional indicators don’t mean what they usually mean. Increases in the monetary base aren’t especially expansionary. The yield curve more or less has to slope up, even if no recovery is expected. And so on.

    So historical correlations, to the extent that they exist — and as Shedlock points out, ECRI is claiming a much better record than it really has — can’t be counted on to prevail. There’s really no alternative to making fundamental analyses of the macro situation.
     

    Ritholtz judgment….


    As we have tirelessly pointed out, there is no indicator that is failsafe. Things that work on occasion sometimes stop working.

    I have found ECRI to be of value to me in my own investing and trading. That does not mean they are flawless or a guarantee — just that they have had value to me.

    While Mish and Lakshman debate their respective track records — Mish is correct in noting that ECRI wasn’t aggressive enough in predicting this recession, and ECRI could point out that MISH failed to see the recovery (or at least the 60+% market rally).

    Traders and Investors should always be looking for the most interesting lesson to be gleaned. In this case, it comes from the Nobel laurelate: There are times when conditions vary so much from prior circumstances that usual metrics are no longer reliable.


    As you know I am a fan of ECRI.  They, along with other factors, gave me plenty of to get out of the market before the big bang.  The argument over the beginning date of the recession of December 2007 is an arbitrary point for investors.  The crap did not begin to hit the fan until May 2009 for the markets – and there is little dispute ECRI was warning strongly by that point.


    ECRI’s data also convinced me to get back in testing the water in March 2009. Did they make a bad call at that point?  Hey, it’s all about investing.


    I could go through the truths, half truths, and misrepresentations by Mish, Krugman, and ECRI.  But it is a waste of my productive time (I am spending today readjusting my portfolio).


    My news flash is ECRI is really the only game in town.  The Conference Board’s LEI is compromised at best.  Even if ECRI’s WLI is inaccurate, you would not throw out their opinion, but you would modify them mentally to match what you believe you are seeing.


    I will use one of Mish’s graphs to make a point.

     


    ECRI claims to predict economic turning points.  In my opinion, they have a pretty good forecasting record for investors.


    Krugman offered no forecasting alternative – only that we make fundamental analysis.  On what basis?  Guesses? 


    As Mish seemed to have a pile of ECRI materials, it seems to me he is also paying money for ECRI’s opinion.  Ritholtz admits he uses the ECRI data.


    As an investor, I will let the economists stand in a circle and do what they do best. 


    What do economists do best?

    Hat tip to Steve at MEMETICS & MARKETING™ for editing support.


    Disclosures: None

     

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This post has 8 comments:

  •  
    Steve - - -

    I have followed this debate with interest. Thanks for bringing it all together. I have questions about how much to believe the table pounding Laksham has done recently on the strength of the year over year change in WLI (the growth rate, which is the usual chart circulated in the world of non-subscribers). I have no doubt that WLI is showing historic growth. But it is coming from very low levels. For this reason, I have to give Barry Rithotz a nod for giving some credence to Krugman's questions.

    And, of course, Mish had some good points also, in a very civil manner. Your chart, from Mish's article, does indeed say it all. Any good chart reader looking at this who did not leave the S&P 500 just below 1400 in early March, 2008 should turn in his chart reading certificate.

    Good job, referee. And you were refereeing the battle over the only game in town.
    Oct 14 11:48 PM | Link | Reply
  •  
    John,

    you hit the nail on the head - the issue is how much we should believe ECRI in their strong recovery opinion. i worry how much the zirp and qe is distorting our normal indicators.

    so far, ECRI has been on target.
    Oct 15 12:11 AM | Link | Reply
  •  
    It seems to me that ECRI is the only one of the bunch without an axe to grind. And I've heard the ECRI guys interviewed in recent months. They haven't been saying that we're headed into a boom. They predicted a transition from negative growth to positive growth, and their opinion was that growth would likely be sluggish. So I'll stick with ECRI.
    Oct 15 12:28 AM | Link | Reply
  •  
    Great article. Great comments. And...another fantastic add to my Favorites list.
    Oct 15 12:51 AM | Link | Reply
  •  
    Sadly the ECRI closely mirrors the market and provides very little leading indication. Perhaps its because so many people rely on it, in which it by neccesity ceases to function as an economic indicator but more like a newsmaking report that directly affects the markets. Thus the chicken and egg issue arises.

    What I and other people look for is things that warn of impending market contractions months before the market recognizes them which is why people tried to develop leading indicators in the first place. Often the market is a leading indicator in itself, but we have all found out recently that it is open to blatant manipulation by dollar devaluation and loose Federal Reserve liquidity policies.

    Today the market does not reflect the economic direction and fundamentals as much as the fact that the Federal Reserve has made US Treasuries and fixed rate investments more risky than they are worth with abnormally low rates and masive dollar depreciation. The market is betting they are even more risky today than the supercharged stock market valuations. Is thi good for us? We will find out if or when we get burned in the stock market again by the Federal Reserves loose monetary policies. Fool me once shame on you. Fool me twice and it appears we are as dumb as a doornail and will never learn a thing.
    Oct 15 02:19 AM | Link | Reply
  •  
    seekingalpha.com/insta...

    Has there been ANY period in history wherein a government or an arm of the government or an independent shadow government in control of monetary policy has actively poured billions of dollars into bond and stock and mortgage markets in an attempt to re-fund inflationary policy?

    If not, then ALL indicators have been compromised. Did the Fed directly re-fund the rally in 2002-3, not just with interest rate decisions, but by pouring money into markets, buying anything that would not sell?

    No indicators mean anything today because the Will of the Fed is the ONLY indicator now. Only when TBill and TBond yields rise will I believe that the Fed is losing control of these markets.
    Oct 15 04:42 AM | Link | Reply
  •  
    Mr Hansen---You say "The crap did not begin to hit the fan until May 2009 for the markets". Did you mean 2009? Enjoyed the article.
    Oct 15 12:24 PM | Link | Reply
  •  
    Steve the chart you have included clearly shows the ECRI WLI to be a coincident indicator at best, and on occasions a lagging indicator -- of the S&P at least. Therefore you can't draw anymore meaningful information from the ECRI WLI than you could from the S&P 500. (qualifier: for this data set dating back to early 01)

    This raises another issue: the debate in various forums is framed around comparisons to the S&P yet discussions are often about prediction of recoveries and recessions. It is an apples and oranges debate. The questions are, or should be:

    Q1. Is the ECRI WLI a leading indicator for the S&P 500?

    A1. Data set provided shows it isn't. It is coincident.

    Q2. Is the ECRI WLI a leading indicator for the economy?

    A2. Who knows. Let's see a plot of the WLI vs GDP. In other words those on each side of the debate should present charts relevant to what they are supposedly debating -- which from my reading of these blogs is the economy not the S&P, unless they want to debate the separate issue of how the S&P correlates to economic growth. I'd therefore give a fail to all protagonists.
    Oct 15 01:50 PM | Link | Reply
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