Saturday, July 31, 2010

ECRI Falls Deeper Into The Abyss

¹²ECRI Falls Deeper Into The Abyss

By BondSquawk | 30 July 2010

The Economic Cycle Research Institute released its Weekly Leading Indices for the week ending July 23. While the Weekly Leading Index ticked up to 121.1 from a downward revised prior period reading of 120.6, the Weekly Growth Rate Index fell further by 0.2% to -10.7 percent. This latest reading marks the 12th decline in a row and the 8th straight week in negative territory, dating back to the first week in June.

The ECRI Weekly Leading Index

By Dshort | 30 July 2010

Note from dshort: This week's update coincides with the release of Q2 GDP, which came in light at 2.4%. Note also that the Real GDP numbers are now updated with the BEA's revised estimates from 2007 through First Quarter 2010. See the explanation here.

Today the Weekly Leading Index (WLI) of the Economic Cycle Research Institute (ECRI) registered negative growth for the eighth consecutive week, coming in at -10.7. This number is based on data through July 23th. The rate of decline from the peak in October 2009 is unprecedented since the metric was first devised in 1967. But before we examine the WLI further, let's first review the relationship between the Gross Domestic Product (GDP) and recessions since 1965. The conventional definition of a recession is two or more consecutive quarters of negative growth. The National Bureau of Economic Research (NBER), charged with establishing official recession start and end dates, doesn't follow convention in making its recession calls— often a year or more after the fact. [[It has not so far identified the end of the recession which 'officially' started in December 2007.: normxxx]]

Click Here, or on the image, to see a larger, undistorted image.

A Leading Indicator For Recessions?

The ECRI WLI growth metric has had a respectable (but by no means perfect) record for forecasting recessions. The next chart shows the correlation between the WLI, GDP and recessions.

Click Here, or on the image, to see a larger, undistorted image.

A significant decline in the WLI has been a leading indicator for six of the seven recessions since the 1960s. It lagged one recession (1981-1982) by nine weeks. The WLI did turned negative 17 times when no recession followed, but 14 of those declines were only slightly negative (-0.1 to -2.4) and most of them reversed after relatively brief periods.

Three of the false negatives were deeper declines. The Crash of 1987 took the Index negative for 68 weeks with a trough of -6.8. The Financial Crisis of 1998, which included the collapse of Long Term Capital Management, took the Index negative for 23 weeks with a trough of -4.5. The third significant false negative came near the bottom of the bear market of 2000-2002, about nine months after the brief recession of 2001. At the time, the WLI seemed to be signaling a 'double-dip' recession, but the economy and market accelerated in tandem in the spring of 2003 [[after huge stimulus by President W. Bush and the Fed: normxxx]], and a recession was avoided.

The Latest WlI Decline

The question, of course, is whether the latest WLI decline is a leading indicator of a recession or a false negative. The index has never before dropped to the current level without the onset of a recession. The deepest decline without a near-term recession was in the Crash of 1987, when the index slipped to -6.8. The next chart includes an overlay of the Federal Funds Rate.

Click Here, or on the image, to see a larger, undistorted image.

Can the Fed take steps to reduce the risk of a near-term recession? Lowering the Fed Funds rate has been a primary tool for stimulating a weak economy. But as the last chart shows, that tool is not any longer available in our current situation.

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