Wednesday, April 02, 2008

ECRI Weekly Leading Index indicator rises moderately sharply but economy still unambiguously on recessionary track

For the first time since early 2001, the Economic Cycle Research Institute (ECRI) has made an official recession call. The ECRI believes that the U.S. economy is now in recession. They did not offer a start date or any forecast for the depth and length of the recession, but on Friday, March 28, 2008 stated clearly that "The U.S. economy is now on a recession track."

We still need to wait for the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER), considered the "official" arbiter of the start and end dates for recessions, to make their call, but they could take six months or more to decide that the U.S. economy is clearly in recession. Martin Feldstein, president of NBER , did in fact publicly state his personal opinion on March 14th that "I believe the U.S. economy is now in recession", but Robert Hall, chairman of the committee simply said that "Given the retrospective nature of our process, no determination of a peak in activity is likely in the next few months", while committee member Jeffrey Frankel noted that "There is a good chance that when all the data are in they will show that we entered a recession in the first months of 2008."

Although I agree with ECRI that there is significant risk that the economy will not pull out of this slump, I remain unconvinced that we truly are in a recession. Although some of the major economic indicators do show some decline from peaks, the declines are way too modest to-date to constitute a "significant" decline in economic activity. For example, real disposable personal income peaked in September, declined for two months, but has now risen for three consecutive months and is now higher than the September level. That is symptomatic of a sluggish economy, but not typical for a recession. To make things murkier, NBER uses real income "excluding transfers", but I have not been able to figure out precisely what data they are subtracting, or why transfers are a required subtraction since they do feed into the economy. I read the data as still not completely pointing to a "significant" and "prolonged" contraction of the economy. Besides, the actual ECRI Weekly Leading Index and its six-month smoothed growth rate have stabilized a bit over the past two months. Unless the WLI resumes its decline, a bounce-back for the economy is still a very real possibility.

Incidentally, the stock market, one of the leading economic indicators used by ECRI and others, has shown remarkable resilience over the past couple of weeks, so we need to be careful about discounting the "wisdom of investors" who appear to be betting heavily that the U.S. economy is not going to deteriorate significantly from the current level of economic activity.

[Data as of Friday] The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose moderately sharply (+0.74% vs. -1.13% last week) and the six-month smoothed growth rate rose modestly (to -10.0 vs. -10.2 last week), but is well below the flat line, suggesting that the economy will be struggling in the months ahead.

The bottom line is that the ECRI WLI remains "flashing red." Alas, even the ECRI WLI is not a guaranteed, fool-proof economic indicator, especially when the data is mixed.

I will leave my personal assessment of the chance of recession at 70% based on the magnitude of the negative level of the WLI smoothed growth index, the ECRI assessment, and the fact that although the data remains mixed, it is strongly biased towards weakness. I am also refraining from going higher that 70% because there has not been enough time for all of the positive stimulus in the pipeline to have had an effect on the real economy coupled with the fact that the WLI has seemed to stabilize a bit over the past two months. The economy still has a very modest chance of avoiding an outright recession, but only if the data starts to improve within the next four to six weeks.

I am still at least somewhat optimistic that the U.S. economy will escape a full-blown recession, but I do have to recognize what the data itself is signalling to me, as well as ECRI's assessment and recession "call." Incidentally, the Intrade Prediction Market rates the probability of a U.S. recession in 2008 at 70%, no different from my own assessment.

-- Jack Krupansky

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