January 10, 2012
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In September 2011, the Economic Cycle Research Institute proclaimed a new U.S recession would begin sometime in the coming year. ECRI based its prediction on a host of its own internal long-leading indexes, together with its widely followed weekly leading index (WLI).
I do not wish to debate the merits of ECRI’s recession call here (I wrote on this topic last week), but since the ECRI WLI is so widely followed – presumably because it is free to the public – I want to focus on the proper use of the WLI and examine its accuracy in recession dating, in order to put this current recession call into context.
The WLI is unique in that it is published weekly, giving more of a real-time view than other indicators, such as the Conference Board leading economic indicator (LEI), the e-forecasting.com eLEI and the Organisation for Economic Cooperation and Development (OECD) LEI.WLI data are available as far back as January 6, 1967, consisting of the WLI itself and a proprietary “growth” column that is used for estimation of recession risk and timing. It is a mystery how ECRI calculates the growth column, and attempts to replicate it with rate-of-change computations on the WLI have proved fruitless. For those curious enough, the closest correlation my firm has achieved in replicating it is 0.966 with a 37-week percentage rate-of-change of the WLI:
The proprietary nature of the WLI always leaves one with a uneasy feeling. A case in point is the period spanning 1990 to 1997, when the WLI suddenly became a lot more volatile, as can be seen in the shaded area of the above chart. At this scale it may be hard to see but zooming into that period and looking at the 37-week %change is more revealing:
The ultimate purpose of any LEI is to enable an investor to forecast business cycle turning points – more specifically, the onset and duration of recession – in a timely fashion. For the purposes of this exercise, we will use the National Bureau of Economic Research (NBER) recession-dating methodology, as they are the official arbiters of recession dating for the U.S.
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