Mon 26 Jul 2010
ECRI WLI: Slowdown or double-dip recession?
Posted by Prieur du Plessis under Economy, US
[6] Comments
A significant number of pundits focus on the ECRI Weekly Leading Index (WLI) in their quest to make sense of the stock market’s most likely direction, whereas some advisors and economists are highly critical of the measure.
But what is the ECRI WLI all about? In short, the Index is a composite of seven key weekly economic indicators published in the U.S. ECRI’s website offers the following explanation: “To monitor just the U.S. economy, ECRI uses an array of 19 specialized leading indices in the context of an “economic cycle cube” covering various sectors and aspects of the economy (see chart below).”
According to ECRI a significant downturn in the WLI forecasts a recession ten months in advance, while a significant upturn precedes the end of a recession by an average of two months. In the past, when the WLI smoothed annualized growth rate fell to -7 and below, it pointed to a contraction in the U.S. economy. With the recent fall to a level of -10.5, commentators are increasingly calling for a double-dip recession in the U.S. From the graph below it seems they have a valid point.
Sources: NBER; ECRI (various internet sources); Plexus Asset Management.
But do they? Let us first consider why the ECRI smoothed annualized growth rate has plummeted. One should bear in mind that many economists and commentators see the calculation of the ECRI WLI as a black box. Obviously the equity and bond markets are probably two of the major leading indicators used in the calculation. Is it a coincidence that the ECRI WLI is so closely correlated with the S&P 500 Index where major turning points coincide?
Sources: I-Net; ECRI (various internet sources); Plexus Asset Management.
The 52-week percentage change of the WLI is normally a reflection of the 52-week percentage change of the S&P 500 Index.
Sources: I-Net; ECRI (various internet sources); Plexus Asset Management.
It is therefore apparent that the equity market successfully calls recessions. However, there are certain periods, such as in 2002–2003, during which diversions were evident, but they can largely be attributed to other leading indicators such as bond rates.
Sources: I-Net; ECRI (various internet sources); Plexus Asset Management.
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