Accurately forecasting where the U.S. economy is headed is not easy, yet everyone has an opinion. Recent economic data has been positive, so most forecasters believe that the U.S. economy is strengthening and the chances of a double-dip recession are receding. Just look at some recent news headlines:
The consensus is clear, as evidenced by the just-released Livingston Survey: no U.S. recession but continued slow growth in 2012. This optimistic consensus, combined with all of the recent positive economic data, has made the Economic Cycle Research Institute’s (ECRI) September 30th recession call look a bit silly. So, when Bloomberg TV’s Tom Keene interviewed ECRI co-founder Lakshman Achuthan yesterday (Dec. 8th), Keene’s first question was understandably skeptical:
What happened to your recession call?
Achuthan’s answer was classic:
Well, it’s happening, what do you mean?
This ECRI guy has real cojones and I think that’s one of the reasons I like him so much. Bottom line: he is supremely confident in his leading economic indicators and he couldn’t care less that the “consensus” disagrees with him.
ECRI is in Wall Street’s Crosshairs
Achuthan’s confidence rubs some Wall Street people the wrong way. For example, someone writing under the pseudonym “Dutch_Book” at Stone Street Advisors wrote back in November:
You have to respect the marbles on a guy with no economics or mathematics training to speak of, calling out everyone on the street (never mind that a few shops are predicting recessions as well) saying that the firm for which he simply is the head of marketing and operations is infallible. It’s awesome stuff, markets are wrong, economists are idiots, him and his subscribers are the smartest people on the planet because they are the only people looking at forward looking indicators.
I am an economist by training and am regularly in touch with both buy side and sell side economists, in house and elsewhere, so the idea that nobody looks at leading indicators is beyond insane.
I’ve never heard of Stone Street Advisors, but I have to respect them since they are smart enough to be located on one of the prettiest and historic streets in all of Manhattan. But I think “Dutch_Book” sounds jealous and defensive. To be fair, “Dutch_Book” isn’t saying that ECRI’s recession call is wrong, just that ECRI is obnoxiously arrogant for claiming that Wall Street economists don’t understand the difference between a “leading” economic indicator and a coincident/lagging one. But, hey, Achuthan is a salesman who is trying to distinguish his firm’s forecasting product from others and it is standard operating procedure to claim that your proprietary indicators are better than the next guy’s. So chill out “Dutch_Book!”
Advertisement puffery doesn’t work unless there is some substance behind it and there is no dispute that ECRI’s forecasting track record is better than most Wall Street economists. It’s a cheap shot for “Dutch_Book” to claim that ECRI’s Weekly Leading Index (WLI) is nothing more than an inverse of the 10-year U.S. Treasury note (NYSE: IEF). The 10-year U.S. treasury note rose significantly in value during the economic slowdown in the summer of 2010 — just like it has recently in 2011 — and yet ECRI did not call a recession in the summer of 2010 while it did call a recession in September 2011. Nope, ECRI’s secret sauce is much more complicated than the 10-year U.S. Treasury note! As I wrote in How to Profit from the Economic Slowdown Dead Ahead, ECRI’s WLI has historically consisted of at least seven different components, only one of which (#7) involves U.S. Treasuries:
- Initial Jobless Claims
- Business Failures
- Real Estate Loans
- Journal of Commerce-ECRI Industrial Materials Price Index
- S&P 500 Stock Price Index
- Corporate Bond Yield Aaa
- Risk Spread Between U.S. Treasury and Corporate Bonds
The Validity of ECRI’s Recession Call Won’t Be Known for Another Year
The recession debate between ECRI and Wall Street won’t be settled today or tomorrow. In fact, Achuthan told Bloomberg TV that the WLI leads economic reality by 6-9 months, so the actual economic downturn probably won’t occur until the first or second quarter of 2012. Since GDP data gets revised, a final answer won’t be available for 12 months. In an October MarketWatch article, Achuthan was quoted as saying:
It really isn’t unusual for the consensus to recognize recessions many months after they have begun because most analysts are focused mainly on coincident indicators like GDP, retail sales and jobs, along with a couple of short leading indicators like the purchasing managers indexes and jobless claims.
Before dismissing ECRI’s recession call, keep the following facts in mind:
- During the Nov. 1973-Mar. 1975 recession, job growth continued until nine months after the recession had started.
- In March 2001, 95% of economists surveyed by The Economist said there would be no recession that year. Yet the recession had already begun in March and would last through November 2001.
- During the Dec. 2007-Jun. 2009 recession, real-time data didn’t show a decline in GDP in the first or second quarters of 2008. In fact, as late as August 2008 (eight months into the recession) there was no confirmation of an economic contraction. It was only when the data was later revised that Q1 2008 was shown to have experienced negative real GDP.
GDI vs. GDP
This time around, much hullabaloo has been made about third-quarter GDP growth of 2.0% “accelerating” from the 1.3% growth in the second quarter. Many Wall Street firms are forecasting even higher 3%-plus GDP growth in the fourth quarter.
But what is getting lost in the mix is the anemic behavior of gross domestic income (GDI), which was up only 0.4% in the third quarter – much lower than the 2.0% rise in GDP. Theoretically, GDI and GDP are two sides of the same coin and must equalize over time. A 2007 Federal Reserve study concluded that GDI is a better forecaster of recessions than GDP. This suggests that future GDP will decelerate towards GDI rather than GDI accelerating towards GDP. If GDI is the destination, then the future of the U.S. economy as measured by GDP does not look bright. According to one commentator:
If the GDI were reported on a consistent basis with the GDP and GNP, where the growth estimates for a quarter are not revised after the third-estimate of a given quarter (until the annual benchmarking), the third-quarter 2011 GDI would have been reported with a 0.8% annualized real quarter-to-quarter contraction.
A GDI contraction doesn’t sound too good for future GDP, no? Even one of the U.S. economy’s cheerleaders – The Economist — concedes that “last August’s forecasts of a seasonal recession [may] turn out to have been early rather than wrong.”
The early bird catches the worm.