Friday, August 21, 2009

Recovery to Be Stronger Than Expected?

Lately it seems that there’s general agreement that some sort of economic recovery is underway, thanks to the massive doses of financial stimulus that have been unleashed to halt the recession. Now, the debate has shifted to whether or not we will experience a typical post-recession recovery pattern, or whether we will enter a “new normal” of permanently lower levels of economic activity due to the severity of the recent downturn. The “new normal” crowd must be making headway, since according to Bloomberg, consensus expectations are for third quarter GDP growth of +2.2%, and for fourth quarter growth of +2.0%. Both of those are below-trend GDP growth rates, and are far less than the strong readings that are typically seen early in an economic recovery.

According to a leading indicator produced by the Economic Cycle Research Institute, however, a stronger than expected rebound in economic activity may be in store, which would come as a surprise to those predicting otherwise. ECRI is a private forecasting firm that has earned quite a reputation for being able to accurately predict major turning points in the economy, with an impressive track record going back many decades. We’ve been watching their U.S. Weekly Leading Index very closely, which is a proprietary leading indicator of the economy that they’ve developed, and over the past several months its growth rate has jumped from an all-time low of -29.7% to +17.5% (shown on the chart below), which is the highest reading since 1983.

The components of their index consist of the money supply, industrial materials prices, mortgage loan applications, corporate bond yields and spreads relative to Treasuries, stock prices, and initial claims for unemployment insurance. Almost all of these have been trending in a favorable direction over the past several months, causing the spike in the overall index. While there may in fact be powerful arguments by those who caution of a “new normal,” the message coming from ECRI’s leading indicator is to expect a much stronger rebound. Whether or not the rebound builds into a more sustainable growth cycle is the next piece of the puzzle for investors to wrestle with.