ACTIONABLE ADVICE FOR FINANCIAL ADVISORS: Newsletters and Commentaries Focused on Investment Strategy

Follow us on
 Facebook  Twitter  LinkedIn  RSS Feed

    Last 14 days

Most Popular Articles

Most Popular Commentaries

    Last 12 Months

Most Popular Articles

Most Popular Commentaries

More by the Same Author

Recession: Just How Much Warning is Useful Anyway?
By Dwaine van Vuuren
February 14, 2012

Go to page Previous, 1, 2     Bookmark and Share  Email Article   Display as PDF

Now for the big surprise: DROP2 is much bigger than DROP1 – almost double! That hits most seasoned investors and clients we have showed this to right between the eyes. If you use any number of well-crafted models that are based on coincident indicators (and there are brilliant ones, including some we have built), you are still likely to avoid two-thirds or more of any recession-related correction. (This assumes, of course, that you time your re-entry to stock market trough perfectly – but we have to assume the two methods will re-enter at the same time when evaluating optimal times to exit.) This stylized fact is not isolated – in five of the seven recessions, this was true, and for the two it was not, DROP2 was not that far from DROP1. Timing exits with co-incident indicators is hardly a worthless approach.

Obviously, it is ideal to exit 4.8 months before recession (on average). But it is not crucial and arguably, unless your leading indicator is dead accurate – which cannot be guaranteed – it is possibly not ideal,unless it has a short lead.

Given the far better dating accuracy one can achieve with statistical models deploying short-leading and/or co-incident indicators, you ignore them at your peril. I say this as many respected leading economic indicators (the ECRI WLI being one) have been whipsawed with false positives of late. One ought to hesitate in basing high-stakes decisions – which is what acting on recession calls are – solely on leading indicators.

Co-incident indicators reflect the real economic reality, whereas leading indicators predict. Co-incident is always going to emerge the winner in the "measure the real economy" contest. That is why statistical models for dating recessions using co-incident indicators are generally more accurate in pinpointing exact start and end dates of recession. Even the NBER itself officially uses a set of co-incident indicators to proclaim recession, not leading ones, although admittedly it does so 8 to 12 months after the fact.

Of course, by their nature co-incident indicators will never offer advance warning, as leading indicators do. But that is not such a huge shortcoming, since their improved accuracy and relatively small one-third loss of efficiency in a high-stakes game still makes them a player in any self-respecting recession model or approach.

By all means use leading indicators, but be aware that risking an entire exit or hedging strategy on leading indicators alone, especially long-leading ones, may not offer the best risk-adjusted approach.

Heading for the hills more than five months before recession is more likely to be counterproductive than not, assuming you are following a business cycle expansion buy-and-hold strategy. Do not isolate your decision points to LEIs only, since they can be subject to false positives and they only give you an extra 33% edge.  Coupling or staging your actions with recession models that use more accurate short-leading and coincident economic indicators will allow you to still capture up to two-thirds of the benefit of timing market exits, while greatly enhancing reliability.

Dwaine van Vuuren is CEO of PowerStocks Investment Research, a South African-based provider of investment research. If you would like to receive the next 4 weeks SuperIndex Recession Reports for free, just email us at with FREE SUPERINDEX AP2 in the subject line.

Go to page Previous, 1, 2

Display article as PDF for printing.

Would you like to send this article to a friend?

Remember, if you have a question or comment, send it to .
Website by the Boston Web Company