Friday, May 16, 2008

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

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell slightly (-0.06% vs. +1.31% last week) but the six-month smoothed growth rate rose moderately sharply (to -7.2 vs. -8.0 last week), which is still well below the flat line, suggesting that the economy will be struggling in the months ahead.

According to ECRI, "While the WLI slipped slightly, its growth rate has come off its lows in recent weeks, reflecting improved financial market sentiment. Still, the WLI is not yet pointing to a business cycle recovery."

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 keep my personal assessment of the chance of recession at 65% based on the fact that we are seeing some hints of moderation mixed in with all of the gloomy news. I will keep my assessment above 50% because we are not seeing persistently clear signs of an upturn, but I will keep it below 80% because we still are not seeing any hint of the steep declines in employment and income typically associated with full-blown recessions. 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 would have been tempted to inch down towards 50%, but 1) industrial production was down, 2) mortgage applications were down, and 3) unemployment initial claims were up.

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 less than half of the most recent 24 weeks of WLI data (10 out of 24) are higher than the current level. That means that even if the WLI remains flat, within three 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.

Incidentally, the Intrade Prediction Market rates the probability of a U.S. recession in 2008 at only 33%, 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 both Q2 and Q3 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 33% 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.

The bottom line is that the economy remains at "the edge" of a recession.

-- Jack Krupansky

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