On Thursday, July 24, 2014, the S&P 500 index reached an all-time record high of 1,991.39. ECRI's Weekly Leading Index, WLI, rose to just 0.3 points below its 6.3-year high of 136.3. SPY, the exchange traded fund for the S&P 500, also set a record high on July 24 and today is just 1% below that high.
Chart 1 Showing S&P500 from 1997 through July 28, 2014
The latest all-time high for the S&P 500 put it over 26% above its 2007 high. The stock market bears who claimed we were in a "Secular Bear Market that began in March 2000" scared many out of the stock market. Those of us who stayed in the markets and added to positions during the downturns are also well above past highs.
Table 1 showing Recent S&P500 Data
In my February 2011 article "How to Play Expected Inflation from the TIPS Spread," I wrote I was long SPY, as one way to benefit from expected inflation. "I also believe it is a good time to own equities including SPY, the exchange traded fund for the S&P 500, for both inflation protection and income."
I have been correct to recommend SPY here on Seeking Alpha for the past few years despite ECRI's fears of a recession.
Currently, SPY adjusted for dividends is over 65% above its 2000 high with dividends reinvested. The raw price index for SPY, without dividends and shown in green on my graph below, also remains above prior highs made in 2000 and 2007.
Chart 2 Showing SPY Adjusted for Reinvested Dividends.
Table 2 showing Recent SPY Data
Despite the markets sitting near record highs and the WLI making a 6.5 year high, the current press release from the Bureau of Economic Analysis estimates Q1-2014 GDP shrank at a 2.9% annual rate.
On Friday, July 15, 2014, the Economic Cycle Research Institute (ECRI), a New York-based independent forecasting group, released its latest readings for its proprietary Weekly Leading Index (WLI) for the period ending during the prior week. In the latest release, for the week ending July 18, 2014:
- WLI was 135.8, up compared with the prior week at 135.1
- The lowest reading for WLI on record was 105.3 for the week ending March 6, 2009.
- WLI growth was positive 4.2%, flat when compared with the prior week also at positive 4.2%.
- The lowest reading for WLI growth on record was negative 29.9% on Dec. 5, 2008. It turned higher months before the stock market bottomed on March 6, 2009, at 666.79.
- Occasionally the WLI level and growth rate can move in different directions, because the latter is derived from a four-week moving average.
Important WLI highs for the last 6 years back to January 2008 are:
- May 9, 2014 = 136.3 (a 6.3 year high)
- January 10, 2014 = 134.2 (a 193 week high at the time)
- April 30, 2010 = 134.9
- May 9, 2008 = 134.1
Annual WLI growth: Based on a simple, year-over-year annualized basis, the annual change in WLI was 3.7% up from the prior week's reading of 3.2%.
ECRI remains cautious for economic growth. In a May 9, 2014, article "Where Are We in Economic Cycle?" ECRI warns that sustained 3% GDP growth will remain difficult while their belief of 2% would be what the Fed calls the "stall speed."
While the consensus keeps predicting an economy at "escape velocity," with sustained 3%-plus growth, the reality remains far short of that, with yoy GDP growth hovering around 2% - what one quickly-forgotten Fed paper had called the economy's "stall speed." Meanwhile, business investment remains elusive and - as ECRI correctly predicted last summer - construction is decelerating, not accelerating, posing risks to the economy now highlighted by Janet Yellen…
There's no indication that this era will end soon, even if we see occasional 3%-plus GDP growth quarters, given that even Japan in its "lost decades" has seen 3%-plus GDP growth in 30% of the quarters since 1990.
If ECRI is correct that we had a recession that will show in future revisions to GDP, would it be one of the 20% of recessions that come without a bear market in stocks? ECRI's managing director, Lakshman Achuthan said, "In three of last 15 recessions there was no bear market, 1980, 1945 & 1926-27. (The) '80 recession was really short, '45 was end of WWII and '26-'27 was Roaring Twenties."
Does SPY Lead WLI or Does WLI Lead SPY?
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. But this is not always the case. Specifically, in the lead up to the last two recessions, the WLI turned down months before the stock market did.
Chart 5: S&P 500 vs. ECRI's WLI Growth Rate
(Note, I would plot SPY vs. WLI, but I don't have the weekly data in my spreadsheet going back as far since I only started trading SPY in early 2007.)
Over the next 10 years, I expect the S&P 500 will keep up with inflation and the dividend it pays should grow with or even exceed inflation. An added benefit to owning equities is that the dividends and capital gains currently get favorable tax treatment. Finally, Treasury rates are artificially low (see Current U.S. Treasury Rates at a Glance) giving all bond funds significant interest rate risk.
I was asked in my Facebook group, "Investing for the Long Term," why I own SPY: "I'm confused; if the ECRI is projecting a recession, why are you long SPY? Is it a market timing strategy?" My answer was:
I don't believe in 'all or nothing' market timing. I explain it more in my newsletter, but I'll adjust my allocation to stocks based on many things including ECRI's outlook. My last two moves for SPY was to sell SOME shares earlier this year when higher and buy them back on June 4, 2012 at $127.50 using 'Auto Buy and Sell targets' in my monthly newsletter. Hope that helps. (Seeking Alpha requires its writers to disclose if we hold a position. Thus, I would report I was long SPY even if SPY was only 1% of the portfolio with the other 99% in cash.)
We had a good discussion of the first estimate of Q1-2013 GDP release in my "Investing for the Long Term" Facebook Group. Several questioned how ECRI could think we were in a recession with 2.5% GDP growth.
I posted Lakshman's answers to our group at Q1 GDP & ECRI Clarification on Recession Call. ECRI believes future revisions to GDP will prove them correct. Here is a key excerpt:
- You're not alone in thinking our recession call was wrong. Still, the facts are that the GDP release on August 28, 2008 - with the economy eight months inside the Great Recession - revised Q2/08 GDP growth to 3.3% from 1.9%, up from 0.9% in Q1/08. But both of those data points, as well as GDP data for the first two quarters of the 2001 and 1990-91 recessions, were subsequently revised by 2 to 4 percentage points over time. This is how real-time data often behave during recessions.
What Does The Future Hold?
Last week, the DOW fell 0.8% while the S&P 500 was essentially flat compared with the prior week. This will give the market a slightly negative influence on WLI for the next weekly reading. It is very possible that SPY and several of the stocks in my newsletter "Explore Portfolio" that lead out of recessions are pointing to an economic recovery even before most economists agree with ECRI that we had a recession.
Will future revisions to GDP show Q4 2012 and Q1-2013 were negative values typical of a recession?
Was the poor 2.9% decline in Q1 GDP a speed-bump due to weather or will Q2-2014 show a reading below positive 3% indicating overall GDP contracted during the first half of 2014?
Chart 7: Excerpt from my 7/22/14 newsletter showing GDP by quarter:
Q1- 2014 GDP was a negative 2.9% that economists blame on bad weather across most of the country. Most economists expect Q2-2014 to be a good quarter with "rebound" spending as consumers return to the malls. Beyond Q2, will we see GDP at or below the 2% "stall speed" or will it be higher?
Clearly taxing savers with massive QE by the Federal Reserve to help the government spend more than it takes in appears to have worked to avoid an "official recession." The average GDP for Q4-2012 to Q1-2013 was only 0.6%. A downward revision of only 0.7%, the mid-range of last year's July revisions for Q1-2011, could show ECRI was right that the US was in a recession.
What do you think?
- I trade SPY around a core position in my newsletter's "Explore Portfolio" and with my personal account. With dividends reinvested, my explore portfolio holds 133.893 shares of SPY with a "break-even" price of $101.78. I also have the index fund version of SPY in both my newsletter's "core" portfolios.
- 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 10, but no recessions resulted (although there were clear growth slowdowns).
- For a better understanding of ECRI's indicators, read its book, "Beating the Business Cycle."
- SPY is the exchange traded fund for the S&P 500 Index.
- VTI is Vanguard's "Total Stock Market" exchange traded fund. If you want to invest in a single fund, that is my first choice over SPY. I recommend SPY and several others in my core portfolios for more opportunities to rebalance.
- VOO is Vanguard's new exchange traded fund that tracks the S&P 500 Index. It is a lower cost alternative to SPY. I own and write about SPY, as I have many years of data for it, but VOO could do slightly better than SPY over time because it has a lower expense ratio.
- S&P500 Chart Scan & SPY Chart Scan
Disclosure: I am long SPY and own the traditional index fund versions of VTI and VOO bought long ago in various taxable and tax deferred accounts. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclosure: The author is long SPY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.