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Recession: ECRI Weekly Leading Index Declines

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    July 23, 2012

    The Weekly Leading Index (WLI) of the Economic Cycle Research Institute (ECRI) slipped to 121.9 from last week’s 122.9, a downward revision from 123.2. See the WLI chart below. The WLI growth indicator (WLIg) rose fractionally, now at -2.3 as reported in Friday’s public release of the data through July 13, an improvement over the previous week’s -2.7 (a downward revision from -2.2).

    Last week on Bloomberg TV, ECRI’s Lakshman Achuthan not only reaffirmed his company’s recession call; he also made the claim that we’re already in recession (link to video).

    A cornerstone of his argument is that four key indicators used by the NBER to make official recession calls are, as he put it, “rolling over.” Here are the four indicators in question. Only one, real retail sales (which is the most volatile of the lot) is showing some contraction.

     

     

    Of course, the recent months for these data series are subject to revision. But, at this point, the latest data contradicts Achuthan’s “rolling over” general assertion.

    For more background on these four economic indicators, see the following articles:

    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.

     

     

    A Closer Look at the ECRI Index

    Let’s take a moment to look at the Weekly Leading Index. The first chart below shows the index 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 15.3% off the most recent high, which was set five years ago in June 2007. The longest stretch between highs was about 5.2 years 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 we’re now witnessing is quite different.

    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.

     

     

    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.

     

     

    A significant decline in the WLI has been a leading indicator for six of the seven recessions since the 1960s. It lagged one recession (1981-1982) by nine weeks. The WLI did turned negative 17 times when no recession followed, but 14 of those declines were only slightly negative (-0.1 to -2.4) and most of them reversed after relatively brief periods.

    Three other three negatives were deeper declines. The Crash of 1987 took the Index negative for 34 weeks with a trough of -6.8. The Financial Crisis of 1998, which included the collapse of Long Term Capital Management, took the Index negative for 23 weeks with a trough of -4.5.

    The third significant negative came near the bottom of the bear market of 2000-2002, about nine months after the brief recession of 2001. At the time, the WLI seemed to be signaling a double-dip recession, but the economy and market accelerated in tandem in the spring of 2003, and a recession was avoided.

    The question had been whether the WLI decline that began in Q4 of 2009 was a leading indicator of a recession. The published index has never dropped to the -11.0 level in July 2010 without the onset of a recession. The deepest decline without a recession onset was in the Crash of 1987, when the index slipped to -6.8. ECRI’s managing director correctly predicted that we would avoid a double dip. The positive GDP since the end of the last recession supports ECRI’s stance.

    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 is currently at a lower level than at the starting month for five of the seven recessions during the published series. The latest weekly reading, -4.6%, is unchanged from last week. The behavior of this indicator over the next quarter or so will be especially interesting to watch.

    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:

     


    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
    “n”= 52/26.5
    “m”= 100

    WLIg = [m*(MA1/MA2)^n] – m

     

    Images: Flickr (licence attribution)

    About The Author

    My original dshort.com website was launched in February 2005 using a domain name based on my real name, Doug Short. I’m a formerly retired first wave boomer with a Ph.D. in English from Duke. Now my website has been acquired byAdvisor Perspectives, where I have been appointed the Vice President of Research.

    My first career was a faculty position at North Carolina State University, where I achieved the rank of Full Professor in 1983. During the early ’80s I got hooked on academic uses of microcomputers for research and instruction. In 1983, I co-directed the Sixth International Conference on Computers and the Humanities. An IBM executive who attended the conference made me a job offer I couldn’t refuse.

    Thus began my new career as a Higher Education Consultant for IBM — an ambassador for Information Technology to major universities around the country. After 12 years with Big Blue, I grew tired of the constant travel and left for a series of IT management positions in the Research Triangle area of North Carolina. I concluded my IT career managing the group responsible for email and research databases at GlaxoSmithKline until my retirement in 2006.

    Contrary to what many visitors assume based on my last name, I’m not a bearish short seller. It’s true that some of my content has been a bit pessimistic in recent years. But I believe this is a result of economic realities and not a personal bias. For the record, my efforts to educate others about bear markets date from November 2007, as this Motley Fool article attests.
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