Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
On Wednesday, December 12, it was reported that the Federal Reserve would extend its easing measures until the job market improves "substantially" and the unemployment rate fell to 6.5%. One can use the unemployment rate model (article link) to forecast the unemployment rate (UER) by applying the typical growth rate pattern of the UER which prevailed during periods between previous recessions to the present time. Accordingly, one can expect the UER to decline to 6.5% by the first quarter of 2014.
The growth of the unemployment rate (UERg) has been negative since the end of September 2010, for 117 weeks so far, and its current level is -10.3%. The unemployment rate will decline further while UERg is negative until UERg becomes positive again, which usually signals a recession start. (The criteria for the model to signal the start of recessions are given in the original article.)
Table 1 below lists the length of the periods and also the corresponding average value of UERg when UERg was negative between previous recessions. One can see that average value of UERg ranged from -7.5% to -9.3% (surprisingly all of similar magnitude), with an average value of -8.7% over those periods. The length of the periods ranged from 103 to 418 weeks, with the average being 245 weeks. (The short 1981 period between the two recessions was not counted, because UERg never went negative then.)
Applying the average value of UERg of -8.7% for the 245 weeks average length of time when UERg was below zero between recessions to the current situation, then we have another 128 weeks to go before UERg becomes positive again, and we can also determine from this the applicable UER and UERg into the future. This is graphed in figure 1 below. Obviously this is only an educated guess, because one does not know the exact length of time for which UERg will remain negative, nor its actual future values, but this is about as near as one can get based on past history.
Figure 1 encompasses the recessions from 1973-2009. The shape of the UERg graph for the period when UERg was negative between recessions have similar patterns, and one can reasonably expect this pattern to be repeated again. One can see that the projected UERg graph between 2010 and 2015 looks similar to previous in-between recession graphs. It will certainly take many weeks before UERg reaches zero, 128 weeks according to the estimate, and the unemployment rate will decline over this period. If the future UERg follows the assumed pattern, then a recession could start in the third quarter of 2015, and not sooner.
Table 2 lists the expected "real time" monthly values of the unemployment rate to January 2016 which would produce the expected UERg pattern. Should the actual reported values be higher than what is shown in the table, then a 6.5% unemployment rate may occur later, or not at all in the foreseeable future, and a recession could possibly start earlier. Alternatively, if the reported values are lower than the listed values, the unemployment rate of 6.5% may be reached earlier than anticipated by the model.
Georg Vrba is a professional engineer who has been a consulting engineer for many years. In his opinion, mathematical models provide better guidance to market direction than financial "experts." He has developed financial models for the stock market, the bond market and the yield curve, all published in Advisor Perspectives. The models are updated weekly. If you are interested to receive theses updates at no cost send email request to email@example.com.