Why ECRI's Recession Call Stands Lakshman Achuthan & Anirvan Banerji March 15, 2012
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Many have questioned why, in the face of improving economic data, ECRI has maintained its recession call. The straight answer is that the objective economic indicators we monitor, including those we make public, give us no other choice.
Let's start with the current state of the economy. A couple of weeks ago, we publicly highlighted ECRI's U.S. Coincident Index (USCI). It's important to understand that the USCI isn't a random concoction of data, but rather the gold standard for measuring current economic growth, as it summarizes the key coincident economic indicators used to determine the official start and end dates of U.S. recessions; namely, the broad measures of output, employment, income and sales. So when USCI growth is in a downturn (bottom line in chart), it's an authoritative indication that overall U.S. economic growth is actually worsening, not reviving.
In contrast to the 3% GDP growth widely reported for the latest quarter, year-over-year growth in GDP, after peaking at 3½% in Q3/2010, has basically flatlined around 1½% for the last three quarters. Broad sales growth has followed a similar pattern, while the growth rates of personal income and industrial production have dropped to their lowest readings since the spring of 2010.
The exception to this weakening pattern is year-over-year payroll job growth, which continued to improve through January, and was essentially flat in February. However, the empirical record shows that job growth typically turns down after downturns in consumer spending growth, not the other way around. Because consumer spending growth remains in a cyclical downturn, we expect job growth to start flagging in the coming months. But the point remains that the USCI, which summarizes the definitive coincident economic indicators "“ including jobs "“ indicates declining growth in the U.S. economy.
How about forward-looking indicators? We find that year-over-year growth in ECRI's Weekly Leading Index (WLI) remains in a cyclical downturn (top line in chart) and, as of early March, is near its worst reading since July 2009. Close observers of this index might be understandably surprised by this persistent weakness, since the WLI's smoothed annualized growth rate, which is much better known, has turned decidedly less negative in recent months. The unusual divergence between these two measures of growth underscores a widespread seasonal adjustment problem that economists have known about for some time.
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WLI and USCI y-o-y growth
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Most data, both public and private, are seasonally adjusted. But the nature of the Great Recession seems to have had an unexpected impact on the statistical seasonal adjustment algorithms that are hard-wired to detect when the seasonal patterns evolve and change over the years. This is normally a good thing, but when the economy fell off a cliff in Q4/2008 and Q1/2009, it was partly interpreted by these procedures as a lasting change in seasonal patterns. So, according to these programs, data from Q4 and Q1 would be expected thereafter to be relatively weak, and therefore automatically adjusted upwards. Our due diligence on this subject indicates a widespread problem, resulting in many recent economic headlines being skewed to the upside.
However, we have no way to objectively measure the extent of these problems "“ either the upward bias for Q4 and Q1 or the downward bias for Q2 and Q3. Fortunately, year-over-year growth rates are naturally less susceptible to these seasonal issues because they involve comparisons to the same period a year earlier that is likely to be skewed the same way. In contrast, smoothed annualized growth rates, which we have traditionally preferred, presume proper seasonal adjustment. While the extent of the seasonal problem will be debated, monitoring year-over-year growth rates is a matter of simple prudence at this juncture not only for ECRI's indexes but also for other economic data.
In the chart, please note the one-to-one correspondence between the cyclical swings in the year-over-year growth rates of the WLI and USCI since the Great Recession. Both surged initially, only to roll over, pop up briefly, and then turn down once again. It is notable that the WLI, which is sensitive to the prices of risk assets that have been supported by massive worldwide liquidity injections, has hardly been swayed from its recessionary trajectory. In spite of the efforts of monetary policy makers, actual U.S. economic growth has slowed, while WLI growth has barely budged from a two-and-a-half-year low.
The bigger question is, can unprecedented, concerted global monetary policy action repeal the business cycle? The objective coincident and leading indexes that we have always monitored are still telling us that it cannot. ———————-
Data source for Coincident Index (XLSX)
Link to USCI and WLI data files: http://www.businesscycle.com/reports_indexes (see "?public indexes' tab near bottom)
Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data, ability to repeat discredited memes, and lack of respect for scientific knowledge. Also, be sure to create straw men and argue against things I have neither said nor even implied. Any irrelevancies you can mention will also be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.
For sure it takes a lot of guts to make a call like this and stick with it.
However, unless we want to become sycophantic to a couple of metrics whose provenance we do not know, we have to look at the facts.
1) Seasonal adjustment is a farce. There is no good reason in this day and
oops! Try again. More coffee.
1) Eschew seasonal adjustment. It is a black box and a farce. 2) unemployment statistics (except U-6 and EMP ratio) are bandpass filters, and over time skew the data,
Why use invisible machinery to produce two numbers we can then argue over?
It seems the concepts in economics are simple enough that open equations (like open source software, and open lab notes) are the way to make data that people can actually analyze. Otherwise we’re just primates banging on two numbers with sticks.
[...] Why ECRI is still looking for a recession. (Big Picture) [...]
Excellent post. Thank you Barry for continuing to provide ECRI’s insights.
Great to have the noise removed from the data, at least that which is possible to remove.
Folks, the two line graphs above appear to have a good track record back to 1990. At a minimum, would not a rational person conclude that an optimistic view of our current economic “recovery” is not warranted just now?
The higher the stock market marches on (with the underlying economy weakening), the higher the probability that a “crash” is being built into the overall system! In seismologic terms, the stresses in the fault zone are building. Make sure you have an escape and survival plan.
Beware “The Ides of March!”
It’s important to listen to the objective data in hand, and kudos to ECRI for not hedging given the data that they see.
I sort of wonder if this is simply a case where getting a little dinged (on the way to a typical recession) still feels pretty good relative to getting kicked in the mouth (the credit bubble implosion).
This is an interesting perspective.
One thing that I have noticed about the ECRI WLI & ECRI WLI, Gr. measures is that – from a casual observation perspective – each appears to have a “dead cat bounce” look. I find this very notable. As well, the ECRI WLI, Gr., while it has been recently consistently improving, is still negative:
http://economicgreenfield.blogspot.com/2012/03/long-term-charts-of-ecri-wli-ecri-wli.html
Another point that Lakshman Achuthan made during a February 24 CNBC interview is the velocity of money. This measure paints a disconcerting trend.
NR,
They will “open source” the numbers when this prediction fails as they will have no value to institutional buyers of this sort of astrology… er… a… economic predictions.
Now it may not happen this time, but it will, probably this time, but no one knows.
4th warmest winter on record has surely made economic data look better than underlying trend
http://www.usnews.com/opinion/blogs/economic-intelligence/2012/03/08/warm-winter-may-have-cooked-economic-data
“The higher the stock market marches on…”
http://finviz.com/quote.ashx?t=AAPL&ty=c&ta=1&p=d ~now ~590/sh.
http://search.yippy.com/search?query=AAPL+one+Stock%27s+perturbation+of+Market+Indices&tb=sitesearch-all&v%3Aproject=clusty
http://www.thefreedictionary.com/perturbation (go with 2.b.) ~~
as an aside, I wonder how many, when reading something like..”…Make sure you have an escape and survival plan…”, actually, give it, Any, thought..
I have a certain amount of respect for Lakshman given the conviction of his calls. However, I’ve always been bothered by two aspects of the interviews that he provides regarding his indices.
First, his descriptions are very opaque, making references to coincident and leading indicators but failing to describe what any of them are. This post helps address at least part of that.
Second, I always remember him saying that his indices are not “models” implying that they are not willy-nilly made up results based on some flawed econometric theory. To me, an index is an series of identifiable observations regarding a well defined metric. To me, his “indices” appear to be some collection of other indices. The fact that it’s a collected result of other inputs, regardless of how crude and rudimentary it’s put together is, by my definition, a “model”. To say that his indices are not models comes across as disingenious or, at the very least, demonstrates a lack of understanding what a model actually is.
I don’t see their sticking with the recession call as a gutsy move. The way I see it, they have no choice — most of the firm’s reputational equity is on the line and a mea culpa at this point won’t salvage much of it.
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