ECRI Update: Flunking Recession 101
Advisor Perspectives (dshort.com)
By Doug Short
December 28, 2012
The Weekly Leading Index (WLI) of the Economic Cycle Research Institute (ECRI) rose in the latest public data. It is now at 128.3 versus the previous week's 127.2. See the WLI chart in the Appendix below. Likewise the WLI annualized growth indicator (WLIg) rose, now at 5.4, up from last week's 4.6. WLIg has been in expansion territory since August 24th, although it is off its 6.0 interim high on October 12th.
ECRI posts its proprietary indicators on one-week delayed basis to the general public, but ECRI's Lakshman Achuthan has switched focus to his company's version of the Big Four Economic Indicators I've been tracking for the past several months. See, for example, this November 29thBloomberg video that ECRI currently features on their website. Achuthan pinpoints July as the business cycle peak, thus putting us six months into a recession.
Here is a chart that clearly illustrates why ECRI's weekly indicators are of little value: The smoothed year-over-year percent change since 2000 of their proprietary weekly leading index. I've highlighted the 2011 date of ECRI's recession call and the July business cycle peak, which the company claims was the start of a recession.
First a flashback for those of us who have followed ECRI's media appearances: we know that the company adamantly denied that the sharp decline of their indicators in 2010 marked the beginning of a recession. But in 2011, when their proprietary indicators were at levels higher than 2010, they made their recession call. For a few months, ECRI's indicators cooperated with their forecast, but that has not been the case in the second half of 2012 -- hence their switch to the traditional Big Four recession indicators. ECRI's December 7th article, The Tell-Tale Chart, makes clear their public focus on the Big Four.
The Big Four
The Big Four Indicators that I track includes real retail sales based on the same formula as the Federal Reserve economists (see this PDF file for details). By this metric, sales continued to increase until October, the data for which was significantly impacted by Hurricane Sandy, but then bounced back in November.
In contrast, ECRI uses Manufacturing and Trade Sales data, which is updated monthly along with the BEA's Personal Consumption and Expenditures release. However, the numbers lag by one month from the other PCE data. The series is available on the BEA website. See Section 0 - Real Inventories and Sales and look for Table 2BU.
Here is a side-by-side comparison of the two measures of sales showing the percent off the all-time high.
Here is a closer look at the pair since 2010. I've used markers to clarify the monthly changes. Note that the latest Manufacturing data, released today, is through October. The Real Retail Sales data I track includes November.
My Personal View...
Now, in the waning days of the year, the media focus is on the December 31st Fiscal Cliff. Meanwhile, the economy, as I've repeatedly remarked, has been walking a tightrope during much of year. However, the rebound in last week's release of the November Personal Income data was quite encouraging. And this follows the strong rebound in November Industrial Production reported the previous week. In my opinion the economic data does not support the claim that a recession began in July 2012. Of course, our politicians could torpedo the economy in early 2012 by mishandling the Fiscal Cliff budget issues.
Here is a snapshot of the version of the Big Four Economic Indictors with Real Manufacturing and Trade Sales.
ECRI can take some temporary solace in their use of the lagging Manufacturing and Trade Sales, which won't include November data until the end of January. But the November strength exhibited by Personal Incomes and Industrial Production certainly undermines their recession call. My take is that ECRI has flunked the "Recession 101" course.
The Usual Caveat: The recent economic data are subject to revision, so we must view these numbers accordingly.
Appendix: A Closer Look at the ECRI Index
The first chart below shows the history of the Weekly Leading Index and highlights its current 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 off 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 11.9% off the most recent high, which was set over five years ago in June 2007. We're now tied with the previously longest stretch between highs, which was 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 in ECRI's indictor is quite different, and this has no doubt been a key factor in their business cycle analysis.
ECRI, however, has "walked the plank" with the company's recession call. And and at this point there's no "Peter Pan" recession to save them from a sea of crocodiles.
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.
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, now at 4.3%, up from 3.6% the previous week. This is higher than at the onset of all seven recessions in the chart timeframe. The closest to the current level was the half of the early 1980s double dip, which was to some extent an engineered recession to break the back of inflation, is a conspicuous outlier in this series, starting with a WLI YoY at 4.1%.
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.
Here is today's update of Georg Vrba's analysis, which is explained in more detail in this article.
Earlier Video Chronology of ECRI's Recession Call
- September 30, 2011: Recession Is "Inescapable" (link)
- September 30, 2011: Tipping into a New Recession (link)
- February 24, 2012: GDP Data Signals U.S. Recession (link)
- May 9, 2012: Renewed U.S. Recession Call (link)
- July 10, 2012: "We're in Recession Already" (link)
- September 13, 2012: "U.S. Economy Is in a Recession" (link)
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
WLIg = [m*(MA1/MA2)^n] – m
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