January 17, 2012
Professor Geoffrey Moore, in his later work "Leading Indicators for the 1990's," laid out in detail his 1980's research into long and short leading indicators, and he also suggested a high-frequency Weekly Leading Index, which, while slightly less reliable, could be updated in a much more timely and frequent fashion. For excellent coverage of a project to replicate the WLI and discover its components (which remain proprietary to this day), see an examination of the model for ECRI's black box.
Many observers, rather unfairly, compare the WLI to monthly LEIs, such as the Conference Board’s. The ECRI WLI, which is a follow-on from Prof. Moore’s work, will no doubt use a number of high-frequency components that many of the standard monthly LEIs will not, and its motivating spirit – to be a high-frequency more timely index that may be less accurate – means we should not condemn the WLI too harshly for false positives. The strong point is its generous lead time going into recessions. The WLI never was intended to be the sole arbiter of recession dating, and ECRI itself uses many longer leading indicators in conjunction with the WLI.
For this reason, we suggest the use of the WLI in a three-step process: First observe the WLIg falling below zero as a warning of possible risk of recession in the future. Then monitor WLIg+ for a 2nd opinion. If both WLIg and WLIg+ are in recession territory you could then consult with WLIg+2 for a third confirmation. If you have 3 confirmations, your last step is to consult with WLIg+1. The four WLI growth indices are shown below as at data published on 13 January 2012, to give an idea how this works:
As you can see from the chart above, you sacrifice a few weeks waiting for further confirmation, but you reduce your odds of actioning a false alarm. You can also see that all four WLI growth variants are camped in recession territory (below the zero line). While this is a fairly serious warning, one should never rely on one indicator for a proper action plan around recession avoidance. More appropriate would be a composite approach, such as our Composite SuperIndex methodology. In this model we use nine indicators, and only the WLI is flagging recession currently.
The WLI is a great tool, and – with the WLIg+ growth variants we described above – it is even more useful for assessing recession risk. But, much like the method it improves upon, it remains subject to false positives.
At the time of writing we were not aware that the actual formula to calculate WLIg was described 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 exact formula we derived from this article: (slightly different to the one we used in this article)
"MA1" = 4 week moving average of the WLI
"MA2" = moving average of MA1 over the preceding 52 weeks
WLIg = [m*(MA1/MA2)^n] – m
The above provides a deviation of 0 versus our original formula that had an average deviation of 0.0026 from the published WLIg. The differences are negligible between the 2 formulas but the more recent one is a 100% mathematical match. Due to the close match of the 2 formulas, everything we have discussed in this article regarding the use of the WLIg+ growth variants for recession detection/forecasting still holds.
Dwaine van Vuuren is CEO of PowerStocks Investment Research, a South African-based provider of investment research. If you would like to receive the next 4 weeks SuperIndex Recession Reports for free, just email us at with FREE SUPERINDEX in the subject line.
Georg Vrba is a professional engineer who has been a consulting engineer for many years. In his opinion, mathematical models provide better guidance to market direction than financial “experts.” He has developed financial models for the stock market, the bond market and the yield curve, all published in Advisor Perspectives. The models are updated weekly. If you are interested to receive theses updates at no cost send email request to .
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