Friday, December 4, 2009

Is the Pace of Recovery Slowing?

The economy has made significant strides over the course of this year. In fact, as most are aware, it returned to a positive 2.8% growth rate in the third quarter, after four consecutive quarterly declines. Of course, there is still much work to be done before the economy returns to a healthier overall state, but it’s been encouraging to see progress being made. We’ve been in the camp that believes the recession most likely ended sometime during the summer, and have highlighted many indicators along the way that were signaling an imminent recovery. However, one of those indicators has recently rolled over, causing us to question whether the pace of recovery is slowing.

The Citigroup Economic Surprise Indicator is a quantitative measure of whether or not daily economic reports are exceeding economists’ expectations. Prior to most economic releases, dozens of economists are usually polled for their predictions. A median of those results is then calculated, which serves as the “consensus” view. If the actual result is higher, it’s considered to be a “positive” surprise, and vice versa. This indicator is designed so that it rises as positive surprises outpace negative surprises. In other words, economic momentum is building. On the other hand, when it’s declining, as it is now, economic data is falling short of expectations, indicating that economic momentum has stalled, and that the economy may soon weaken.

As shown on the chart below, the indicator bottomed last December, several months before equities, and soared higher into early June – clearly ahead of actual improvement in the economy. It then moved in a volatile, sideways fashion during the summer, but has recently rolled over and fallen back to where it was in March. This has certainly caught our attention, but since other economic measures and market-based technical indicators we follow are still holding up, we remain cautiously optimistic for now.