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.

It is also evident that the smoothed annualized growth rate of the ECRI WLI leads the 52-week percentage change of the WLI. This is probably due to the calculation method of the smoothed growth rate where weighted moving averages are applied.

Sources: ECRI (various internet sources); Plexus Asset Management.

Although the smoothed annualized growth rate tends to lead the 52-week percentage change of the ECRI WLI, it can be expected that the smoothed annualized growth rate of the ECRI WLI will also lead the 52-week percentage change of the S&P 500.

Sources: I-Net; ECRI (various internet sources); Plexus Asset Management.

Just beware of the numbers. Over the past 340 weeks 86% of the 52-week percentage change in the ECRI WLI can be explained by the 52-week percentage change in the S&P 500. The massive oversold levels of the S&P 500 Index in February and March last year and the subsequent huge rise then culminated in a significant rise in the WLI. By just focusing on movements in the equity market one may therefore get a wrong signal on recession forecasts.

If the same relationship between the 52-week percentage changes of the WLI and S&P 500 persists and we assume that over the next 52 weeks the S&P 500 will be:

• unchanged at 1,102

• 10% lower at 992

• 10% higher at 1,212

it is evident that the 52-week percentage change of the WLI will continue to lose momentum for the next 40 weeks in all three cases.

Sources: ECRI (various internet sources); Plexus Asset Management.

Sources: ECRI (various internet sources); Plexus Asset Management.

Sources: ECRI (various internet sources); Plexus Asset Management.

With the smoothed annualized rate of the WLI likely to lead the WLI growth rate, the former is likely to gain traction sooner.

It is probably the numbers game that concerns ECRI, as Lakshman Achuthan and Anirvan Banerji in their response to recent criticism in a report from Bank of America stated:

“Bottom line, neither the ’experts’ predicting that the sky is falling based on the WLI, nor the other ’experts’ indulging in misinformed WLI-bashing in an effort to discredit the super-bears, have a real clue as to what the WLI is all about. We created the WLI not to be an infallible, stand-alone recession-forecasting machine, but as one small part of a much larger array of leading indices (each made up of many economic indicators) — like the especially prescient U.S. Long Leading Index. This array amounts to a sophisticated sequential signaling system of the economy’s cyclical turning points. The WLI is designed to be interpreted in this broader context, and its message today is quite simple: a slowdown in U.S. economic growth is imminent, but a recession is not.”

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Source: CNBC, July 26, 2010.

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Sources: Dismal Scientist; Plexus Asset Management.

The significant improvement in the euro zone’s largest economy is sure to rub off on the entire economic region. The IFO Business Expectations Index leads the GDP-weighted PMI (manufacturing and services) of the euro zone by approximately one month. The strong Business Expectations Index number for July therefore suggests that the GDP-weighted PMI in August should be strong as well – on top of that of the flash estimates for July that surprised analysts and commentators on the upside.

Sources: Dismal Scientist; Plexus; Markit.

The numbers should continue to be supportive of European equity prices.

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With the GDP-weighted PMI (manufacturing and services) leading the economy by approximately one quarter the outlook for the UK economy in the third quarter of this year is positive. On a year-ago basis, output could exceed 2%.

Sources: Dismal Scientist, Markit; Plexus Asset Management.

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Note: The transcript of this interview is not available yet, but will be posted here as soon as it arrives.

Source: Wealthtrack, July 23, 2010.

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• John Hussman (Hussman Funds): Betting on a bubble, bracing for a fall, July 26, 2010.
If you exclude the bubble valuations of 1995-2007, the current valuation of the S&P 500 is near the highest level ever observed in history. To expect valuations to expand from here is to rely on the sustained resumption of bubble valuations that have ultimately been devastating to investors.

• Paul Murphy (FT Alphaville): Rosenberg’s 17 reasons to be bullish (seriously), July 23, 2010.
Count ‘em! We’d better capture these bullish talking-points from Gluskin Sheff’s David Rosenberg, just in case they disappear…

• John Mauldin (Thoughts from the Frontline and Investors Insight): Some thoughts on deflation, July 24, 2010.
It seems that not everyone is ready to join the deflation-first, then-inflation camp I am currently resident in. So in this week’s letter we look at some of the causes of deflation, the elements of deflation, if you will, and see if they are in ascendancy.

Ambrose Evans-Pritchard (Telegraph): The death of paper money, July 26, 2010.
There is a clear temptation for the West to extricate itself from the errors of the Greenspan asset bubble, the Brown credit bubble, and the EMU sovereign bubble by stealth default through inflation. But that is a danger for later years. First we have the deflation shock of lives. Then — and only then — will central banks go to far and risk losing control over their printing experiment as velocity takes off. One problem at a time please.

• John Authers (Financial Times): Investors face a world of correlation, July 23, 2010.
The world trades in unison. Many bright people spend many long hours pondering which stocks, sectors or countries to buy but, of late, it scarcely seems to matter.

• Felix Salmon (Reuters): The silver lining to the lenient stress test, July 23, 2010.
There’s a certain amount of relief in the markets that there’s absolutely nothing in the way of bad news coming out of the European bank stress tests. Essentially, the tests could be tough or they could be lenient; and there could be significant failures or no significant failures. The outcome, in the end, was that the tests were lenient and that there were no significant failures. Clearly, a tough test with no significant failures would have been better news – but at the same time, a lenient test with significant failures would have been worse news. So we’re somewhere in the middle, and muddling along: in the CDS market, most banks have seen their spreads tighten modestly, by single-digit amounts, according to Markit.

• Michael Snyder (Seeking Alpha): The one economic chart that really matters, July 22, 2010.
The truth is that by almost any measure, we are in worse economic condition than we were right before the beginning of the Great Depression. We have been living way beyond our means and the debts we have been piling up are clearly not anywhere close to sustainable.

• •Robert Shiller (Project Syndicate): Who should safeguard financial stability? July 22, 2010.
Central bankers around the world failed to see the current financial crisis coming before its beginnings in 2007. Martin Čihák of the International Monetary Fund reported in July 2007 that, of 47 central banks found to publish financial stability reports (FSRs), “virtually all” gave a “positive overall assessment of their domestic financial system” in their most recent reports. And yet, although these central banks failed us before the crisis, they should still play the lead role in preventing the next crisis. That is the conclusion, perhaps counterintuitive, that the Squam Lake Group, a think tank of 15 academic financial economists to which I belong, reached in our recently published report, “Fixing the Financial System”.

• Laurence Kotlikoff (Financial Times): Uncle Sam has worse woes than Greece, July 25, 2010.
During the past half-century, the US has sold tens of trillions of unofficial IOUs, leaving it with liabilities to pay Social Security, Medicare and Medicaid benefits that total 40 times official debt.

US: Earnings, economic reports on tap
Exxon, Chevron, Boeing and Sprint lead a long list of earnings reports. An equally long list of economic data, including GDP, consumer sentiment, unemployment and new-home sales awaits investors.

Europe: BP and Shell report
European markets will get their first chance to react to the bank stress tests, with the latest earnings from BP, Royal Dutch Shell, Deutsche Bank and UBS all likely to be closely watched.

Asia: Raft of earnings reports
Results due from electronics giants Sony, Panasonic, LG Electronics and Samsung; auto makers Honda and Mahindra, and Japan’s largest bank, Mitsubishi UFJ.

Source: MarketWatch (here, here and here), July 23, 2010.

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A member of Parliament to Disraeli: “Sir, you will either die on the gallows or of some unspeakable disease.”
“That depends, Sir,” said Disraeli, “whether I embrace your policies or your mistress.”

“He had delusions of adequacy.” – Walter Kerr

“He has all the virtues I dislike and none of the vices I admire.”  - Winston Churchill

“I have never killed a man, but I have read many obituaries with great pleasure.” Clarence Darrow

“He has never been known to use a word that might send a reader to the dictionary.” – William Faulkner (about Ernest Hemingway).

“Thank you for sending me a copy of your book; I’ll waste no time reading it.” – Moses Hadas

“I didn’t attend the funeral, but I sent a nice letter saying I approved of it.” – Mark Twain

“He has no enemies, but is intensely disliked by his friends..” –  Oscar Wilde

“I am enclosing two tickets to the first night of my new play; bring a friend…. if you have one.” – George Bernard Shaw to Winston Churchill
“Cannot possibly attend first night, will attend second.. if there is one.” – Winston Churchill, in response.

“I feel so miserable without you; it’s almost like having you here.” – Stephen Bishop

“He is a self-made man and worships his creator.” – John Bright

“I’ve just learned about his illness. Let’s hope it’s nothing  trivial.” – Irvin S. Cobb

“He is not only dull himself; he is the cause of dullness in  others.” – Samuel Johnson

“He is simply a shiver looking for a spine to run up.” – Paul Keating

“In order to avoid being called a flirt, she always yielded easily.” – Charles, Count Talleyrand

“Some  cause happiness wherever they go; others, whenever they go.” – Oscar Wilde

“He uses statistics as a drunken man uses lamp-posts… for support  rather than illumination.” – Andrew Lang (1844-1912)

“He has Van Gogh’s ear for music.” – Billy Wilder

“I’ve had a perfectly wonderful evening. But this wasn’t it.” –  Groucho Marx.

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Source: Gregory White, Business Insider, July 21, 2010.

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