Saturday, May 03, 2008

ECRI Weekly Leading Index indicator falls slightly but index remains deep in recession territory

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell slightly (-0.14% vs. +0.09% last week) but the six-month smoothed growth rate rose sharply (to -8.7 vs. -9.8 last week), still well below the flat line, suggesting that the economy will be struggling in the months ahead.

The decline this week was in part due to rising unemployment insurance initial claims and falling mortgage applications. Both are very volatile.

According to ECRI, ""While the WLI has recovered slightly in the last four weeks, it remains close to its March low and in a clear recessionary downswing."

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 and there is a lot of stimulus as well as potential problems in the pipeline.

I will lower my personal assessment of the chance of recession to 65% (from 75%) based on the fact that we are seeing some hints of moderation mixed in with all of the gloomy news. Still, I will keep my assessment above 50% because we are not seeing clear signs of an upturn. The economy still has a moderate chance of avoiding an outright recession, but only if the data continues to moderate and/or improve at an increasing pace.

I am 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."

I would note that in five weeks, less than half of the most recent 24 weeks of WLI data will be higher than the current level. That means that even if the WLI remains flat, within two months the very negative readings on the smoothed growth index will have risen to 0.0. Alas, that is more an artifact of how the smoothed growth rate is calculated than an indicator of economic strength. But, that rise cannot occur if the so-called recession "worsens." The smoothed growth rate rising to 0.0 presumes that the economy does not weaken further. The WLI is currently higher than eight of the past thirteen weeks. There are some promising signs here, but some mixed signals as well.

Incidentally, the Intrade Prediction Market rates the probability of a U.S. recession in 2008 at only 30%, down from roughly 70% before the Q1 GDP report, but that is because their "contract" is written with rules that are based on the traditional rule of thumb that a recession begins with two consecutive quarters of negative real GDP growth, and the rules require the final estimate, which comes out two months after the initial or "advance" estimate. Although it is possible that Q1 could be revised to be negative when the final estimate comes out at the end of June, it is somewhat unlikely, so the earliest that this contract could payoff would be at the end of December when the final estimate for Q3 comes out and even then only if Q2 is negative. If Q2 comes in slightly positive and Q3 comes in negative, contract holders would have to wait until the end of March next year for the final estimate for Q4. The fact that this contract is at 30% says that people expect Q1 to hold positive for its final estimate and that the economy will strengthen in the second half of the year even if Q2 comes in negative. Here are their actual rules:

This contract will settle (expire) at 100 ($10.00) if the United States economy goes into recession during 2008.

The contract will settle (expire) at 0 ($0.00) if the United States economy DOES NOT go into recession during 2008.

For expiry purposes, a recession is defined as two successive quarters of negative real GDP growth.

Expiry will be based soley on the data reported by the U.S. Department of Commerce (Bureauof Economic Analysis, Table 1.1.1, "Percent Change From Preceding Period in Real Gross Domestic Product") as reported by the BEA.

If the table as reported at that time indicates that any two consecutive quarters between (and including) Q4 of the previous year and Q4 of the year specified in the contract are negative, then the contract will expire at 100. Otherwise, the contract will expire at 0. For example, if Q4 of 2007 and Q1 of 2008 both experience negative growth then the contract for 2008 will expire at 100.

Clarification: (added 26 Sept 2007) The final figures will be used for expiry - not the advance or preliminary numbers.

-- Jack Krupansky

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