ECRI Weekly Leading Index: Running in Place
Advisor Perspectives (dshort.com)
By Doug Short
October 26, 2012
The Weekly Leading Index (WLI) of the Economic Cycle Research Institute (ECRI) rose fractionally in the numbers released today. It is now at 126.8, up from last week's 126.6 (revised from 126.7). See the WLI chart below. However, the WLI growth indicator (WLIg) slipped slightly in expansion territory, not at 6.0, down from last week's 6.1. WLIg has now spent nine consecutive weeks of in expansion territory. But essentially the WLI has been running in place for the past five weeks.
The indicators ECRI shares with the public simply aren't supporting the company's repeated recession forecasts which subsequently evolved into an assertion that we are already in a recession. Improvements in Consumer Sentiment and the Advance Estimate of Q3 GDP likewise contradict ECRI's recession call made 13 months ago.
Here is a chronology of selected interviews with Lakshman Achuthan, ECRI's chief operations officer, on Bloomberg TV since its first public recession forecast on September 30th of last year. As I type this, the last item in this list below is still the headline feature at the ECRI website, including a stern-faced Achuthan:
With the weakness we've seen so far in Q3 corporate earnings and lowered outlooks for Q4, the risk of a near-term recession remains a reality. But at this point, ECRI's 13-month old recession call (made to its private clients on September 21, 2011) and the company's claim since mid-summer that we are already in a recession appear to be mistaken. Note that the September 2011 date was the same day that theFOMC press release announced QE2. Essentially ECRI bet against the Fed, generally not a smart strategy.
The explanation of how ECRI continues to justify its recession call in light of weak but not recessionary economic data is this recent post on the company's website: The 2012 Recession: Are We There Yet? In particular this commentary explains in more detail the July claim that key economic indicators were "rolling over".
|In the current cycle retail sales have already peaked back in March 2012 and, according to the household survey, employment has declined for the last two months, and for four of the last six months. Mind you, the household data is revised a lot less than the payroll jobs data and also tends to lead it a bit at cycle turns. (While the jobless rate, calculated from the same data, is yet to turn up in this cycle, that is mostly due to people dropping out of the labor force.)
Since July, when we highlighted the weakness in personal income growth, there have been revisions showing even weaker income growth going back a few months, followed by some apparent recovery recently. As with some of the other coincident data, this series will come under significant revision in the months (and years) ahead. Nevertheless, the weakness in income growth is showing through in retail sales data, which, as mentioned, has actually declined since March.
Are We Now Seeing Signs that a Recession is Underway?
The most recent Big Four Economic Indicators was the release of the September Real Sales and Industrial Production data earlier last week. Here is one of my Big Four charts with ECRI's 2011 recession call annotated. And note especially the table below.
The latest Real Retail Sales number and revisions show a strong rebound over the past three months, with the latest data exceeding consensus expectations. Industrial Production also surprised to the upside. However, the average of the Big Four (the gray line in the chart above) has been moving in stutter-step growth for the past eight months. ECRI also asserts that the recent months for these data series are subject to revision -- downward revision, in their view, although that was not the case for the latest Retail Sales, which were revised higher.
On Monday (October 29th) we'll get last of the Big Four indicators for September: Real Personal Income Less Transfer Payments. This indicator has been showing signs of weakness, so Monday's update will be of critical importance. Will we see signs of income growth to support the rise in Retail Sales, which could ultimately lead to the need for more jobs?
It is not impossible that the NBER may determine, based on future downward revisions to data, that a recession began at some point in 2012, but the performance of the Big Four does not currently support that expectation.
Note: For more another perspective on the Big Four economic indicators, see the following article by Dwaine van Vuuren: The NBER Co-incident Recession Model: "Confirmation of Last Resort".
For a less deterministic view on the US economy from another independent economic "think tank", seethis commentary on the Conference Board's latest Leading Economic Index update. Their latest update, as of yesterday (October 18th) sees the US economy "fluctuating around a slow-growth trend," which is precisely what our average of the Big Four charted above illustrates.
Appendix: A Closer Look at the ECRI Index
The first chart below shows the history of the Weekly Leading Index and highlights its current 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 chart above illustrates, only once has a recession occurred without the index level achieving a new high -- the two recessions, commonly referred to as a "double-dip," in the early 1980s. Our current level is 11.9% off the most recent high, which was set over five years ago in June 2007. We're now tied with the previously longest stretch between highs, which was from February 1973 to April 1978. But the index level rose steadily from the trough at the end of the 1973-1975 recession to reach its new high in 1978. The pattern in ECRI's indictor is quite different, and this has no doubt been a key factor in their business cycle analysis.
The WLIg Metric
The best known of ECRI's indexes is their growth calculation on the WLI. For a close look at this index in recent months, here's a snapshot of the data since 2000. It is the recent behavior of this indicator that most clearly suggests that ECRI has painted itself into a corner with its unequivocal recession call.
Now let's step back and examine the complete series available to the public, which dates from 1967. ECRI's WLIg metric has had a respectable record for forecasting recessions and rebounds therefrom. The next chart shows the correlation between the WLI, GDP and recessions.
The History of ECRI's Latest Recession Call
ECRI's weekly leading index has become a major focus and source of controversy ever since September 30th of last year, when 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.)
Year-over-Year Growth in the WLI
Triggered by another ECRI commentary, Why Our Recession Call Stands, I now include a snapshot of the year-over-year growth of the WLI rather than ECRI's previously favored method of calculating the WLIg series from the underlying WLI (see the endnote below). Specifically the chart immediately below is the year-over-year change in the 4-week moving average of the WLI. The red dots highlight the YoY value for the month when recessions began.
As the chart above makes clear, the WLI YoY, now at 5.5%, is higher than at the onset of all of the seven recessions in the chart timeframe. The second half of the early 1980s double dip, which was to some extent an engineered recession to break the back of inflation, is a conspicuous outlier in this series, starting with a WLI YoY at 4.1%. At this point the WLI YoY, at 5.5%, is significantly higher than that data point.
Additional Sources for Recession Forecasts
Dwaine van Vuuren, CEO of RecessionAlert.com, and his collaborators, including Georg Vrba and Franz Lischka, have developed a powerful recession forecasting methodology that shows promise of making forecasts with fewer false positives, which I take to include excessively long lead times, such as ECRI's September 2011 recession call (barring a future NBER announcement of a Q1 2012 recession start).
Here is their latest snapshot of the WLI growth variants, which should be studied in the context of the analysis at the Shadow Weekly Leading Index Project.
Here is today's update of Georg Vrba's analysis, which is explained in more detail in this article.
Additional Analysis on Recession Forecasting
Here are some links to some useful articles for evaluating the substance of the ECRI's controversial recession call, including work by Dwaine and others:
- July 10: Recession is Not Imminent
- June 26: Recession or No Recession: Is ECRI's Weekly Leading Index Still Relevant?
- April 17: The Unemployment Rate: A Coincident Recession Indicator
- May 2: Can the US Skirt a Global Recession?
- March 6: ECRI's Recession Call: "Is There Something Magic About 2 Percent?" Georg Vrba digs into ECRI's claims about the year-over-year growth rate of its indicators.
- March 3: The Elusive 2012 Recession: When Can We Expect It? Georg Vrba and Dwaine van Vuuren introduce the RecessionAlert.com website.
- February 21: Evaluating Popular Recession Indicators Georg Vrba offers a critique of three recession indicators, including ECRI's WLI and WLIg.
- February 17: No Wonder ECRI's Weekly Leading Index Data is Free Kishor Bhatia points out the remarkable similarity between the WLI and the S&P 500.
- February 14: Recession: Just How Much Warning is Useful Anyway? Dwaine van Vuuren questions the benefit of recession forecasts for portfolio management.
- January 18: Why the Average Investor Is Bamboozled by Recession Forecasts by Jeff Miller.
- January 17: Further Improving the Use of the ECRI WLI by Dwaine van Vuuren and Georg Vrba)
- January 10: Using the ECRI WLI to Flag Recessions by Dwaine van Vuuren
- January 3: US Recession - An Opposing View by Dwaine van Vuuren.
Note: How to Calculate the Growth series from the Weekly Leading Index
ECRI's weekly Excel spreadsheet includes the WLI and the Growth series, but the latter is a series of values without the underlying calculations. After a collaborative effort by Franz Lischka, Georg Vrba, Dwaine van Vuuren and Kishor Bhatia to model the calculation, Georg discovered the actual formula in a 1999 article published by Anirvan Banerji, the Chief Research Officer at ECRI: The three Ps: simple tools for monitoring economic cycles - pronounced, pervasive and persistent economic indicators.
Here is the formula:
"MA1" = 4 week moving average of the WLI
"MA2" = moving average of MA1 over the preceding 52 weeks
WLIg = [m*(MA1/MA2)^n] – m
(c) Advisor Perspectives