The Weekly Leading Index (WLI) growth indicator of the Economic Cycle Research Institute (ECRI) posted -7.6 in its latest reading, data through December 23. The latest public data point is virtually unchanged from last week's -7.7. The index has been hovering in a narrow range between -7.4 to -7.8 for the past seven weeks. Those of us who follow this indicator are nervously awaiting a confirmation or reversal of the trend.
Earlier this month Lakshman Achuthan, the Co-founder of ECRI, spoke with Tom Keene on Bloomberg Television's Surveillance Midday. You can watch the video on the ECRI website here, with bold heading Recession Update. The eight-minute video is well worth watching in its entirely.
As I've repeatedly emphasized, ECRI's recession call is quite controversial in financial circles. The perma-bears are generally supportive of the forecast, while the predominantly bullish mainstream financial view ranges from skeptical to dismissive. The bullish view was supported yesterday by the latest Conference Board Leading Economic Index update. One of the Board's economists forecast "continued growth this winter, possibly even gaining momentum by spring" (more here).
See also the fascinating article, A peek inside ECRI's black box, by an anonymous analyst who uses "New Deal democrat" as a by-line. The article shares the mainstream skepticism of ECRI's recession call, but it does so with an intelligent commentary and several supportive graphs.
On September 30th, ECRI publicly announced that the U.S. is tipping into a recession, a call the Institute had announced to its private clients on September 21st. Here is an excerpt from the announcement:
Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there's nothing that policy makers can do to head it off.
ECRI's recession call isn't based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down — before the Arab Spring and Japanese earthquake — to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not "soft landings." (Read the report here.)
For a close look at this movement of this index in recent months, here's a snapshot of the data since 2000.
Now let's step back and examine the complete series available to the public, which dates from 1967. ECRI's WLI growth metric has had a respectable record for forecasting recessions and rebounds therefrom. The next chart shows the correlation between the WLI, GDP and recessions.
A significant decline in the WLI has been a leading indicator for six of the seven recessions since the 1960s. It lagged one recession (1981-1982) by nine weeks. The WLI did turned negative 17 times when no recession followed, but 14 of those declines were only slightly negative (-0.1 to -2.4) and most of them reversed after relatively brief periods.
Three other three negatives were deeper declines. The Crash of 1987 took the Index negative for 34 weeks with a trough of -6.8. The Financial Crisis of 1998, which included the collapse of Long Term Capital Management, took the Index negative for 23 weeks with a trough of -4.5.
The third significant negative came near the bottom of the bear market of 2000-2002, about nine months after the brief recession of 2001. At the time, the WLI seemed to be signaling a double-dip recession, but the economy and market accelerated in tandem in the spring of 2003, and a recession was avoided.
The question had been whether the WLI decline that began in Q4 of 2009 was a leading indicator of a recession. The published index has never dropped to the -11.0 level in July 2010 without the onset of a recession. The deepest decline without a recession onset was in the Crash of 1987, when the index slipped to -6.8. ECRI's managing director correctly predicted that we would avoid a double dip. The nine quarters of positive GDP since the end of the last recession supports ECRI's stance.
The Certainty and Dramatic Language of ECRI's New Recession Call
What is particularly striking about ECRI's current recession call is the fervor and certainty of the language in the public press release:
Here's what ECRI's recession call really says: if you think this is a bad economy, you haven’t seen anything yet. And that has profound implications for both Main Street and Wall Street.
I continue to be astonished at the complete absence of wiggle room in the announcement, nor have there been any public communications from ECRI to qualify or soften its recession call. ECRI has put its credibility on the line. As I've said before, if the U.S. avoids a recession, ECRI's reputation will be permanently damaged.
A Look at the Underlying index
With the Growth Index showing so little change over the past seven weeks, let's take a moment to look at the underlying Weekly Leading Index from which the Growth Index is calculated. The first chart below shows the index level.
For a better understanding of the relationship of the WLI level to recessions, the next chart shows the data series in terms of the percent of the previous peak. In other words, a new weekly high registers at 100%, with subsequent declines plotted accordingly.
As the second chart illustrates, only once has a recession occurred without the index level achieving a new high -- the two recessions in the early 1980s, commonly referred to as a "double-dip" recession. Our current level is 14.1% off the most recent high, which was set 4.6 years ago. The longest stretch between highs was about 5.2 years from February 1973 to April 1978. But in index level rose steadily from the trough at the end of the 1973-1975 recession to reach its new high in 1978. The pattern we're now witnessing is quite different.
But What About the 1.8% Q3 GDP?
Even with the downward revision from 2.5% to 2.0% to 1.8% for the third estimate of Q3 GDP, many will see the postive Q3 GDP as a repudiation of ECRI's recession call. ECRI itself did not offer a specific date for the start of the forecast recession. A general view is that ECRI's headlights shine about six months into the future, which would make Q1 2012 GDP the critical number for evaluating ECRI's stance.
The U.S. has had eleven recessions since the earliest quarterly GDP calculations, which began in 1948. In the month declared by the National Bureau of Economic Research (NBER) as the beginning of the recession, quarterly GDP for that month has only been negative four times.
ECRI doesn't provide the general public with the analytical details behind its calls, but latest the Hoisington Investment Management quarterly report a similar forecast for negative growth with an interesting analysis that warrants close reading. Here is the opening paragraph and a snippet near from the conclusion:
Negative economic growth will probably be registered in the U.S. during the fourth quarter of 2011, and in subsequent quarters in 2012. Though partially caused by monetary and fiscal actions and excessive indebtedness, this contraction has been further aggravated by three current cyclical developments: a) declining productivity, b) elevated inventory investment, and c) contracting real wage income....
In summary, the case for an impending recession rests not only on cyclical precursors evident in productivity, real wages, and inventory investment, but also on the dysfunctionality of monetary and fiscal policy.
The full report in PDF format is available at the Hoisington website.
More recently Van Hoisington reiterated his view of a coming recession in a Barron's interview:
Our expectation is that we are going to enter another recession next year, when we haven't really fully recovered from the previous one. We think we are in what Niall Ferguson, a Harvard historian, recently termed a slight depression. This isn't a normal business cycle.
For some additional perspective on ECRI indicators and the apparent conflict between its recession call and the Conference Board's Index of Leading Economic Indicators, see my commentary The Great Leading Indicator Smackdown.