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©©Economic Cycle Research Institute (ECRI)Economic Cycle Research Institute (ECRI)

The Great Recession,The Great Recession,and Recoveryand Recovery

September 24, 2009September 24, 2009

This is an interesting time to be talking about business cycles.

Recently the NY Times magazine ran a big piece by Paul Krugman asking “How Did Economists Get it so Wrong?”

Some think this recession was unprecedented so maybe they have a point?

But getting it wrong is nothing new, in fact it’s par for the course.

Some years back the IMF did a 63-country study on how well economist predicted recessions and here’s the punch line…

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A Record of FailureA Record of Failure

““The record of failure to predict recessions isThe record of failure to predict recessions isvirtually unblemished.virtually unblemished.””

–– IMF (2001)IMF (2001)

So it’s very tempting to think that given the current state of the art, it’s virtually impossible to reliably predict recession and recoveries.

I’m here to show you something different.

ECRI was founded to study the business cycles by Geoffrey Moore who The Wall Street Journal called, “the father of leading indicators.”

He passed away in 2000 after a 60-year career of studying recessions and recoveries, in the course of which he came up with the first ever list of leading indicators of recession and recovery, the original index of leading economic indicators and much more including in the early 1980s what we call the Weekly Leading Index, or WLI.

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Weekly Leading IndexWeekly Leading Index

Shaded areas represent U.S. business cycle recessions.

Aug.

This is an index that’s been around for over a quarter of a century, and over that time (shown here) it has correctly predicted every recession and recovery in real-time.

I need to repeat that, over this entire time period, I was present to see each of the correct recession and recoveries calls in real-time, without false signals in between.

Considering the track record of economists in predicting recessions, and even what Krugman is saying, this is surely worth noting.

In discussing where we are in the business cycle and where we are headed, I’m going to start with the lead up to the Great Recession.

In essence the real-time performance of this leading index right here (2007).

Please note the WLI peaked in June 2007, six months before the recession began.

Let’s now zero in on the much more sensitive rate of growth of the WLI during this two-year period.

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Weekly Leading Index Growth Rate (%)

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This chart starts in January 2007.

I’m going to take you through what we wrote in real-time at each of these points as the recession and recovery evolved.

This five minute process will help you to better appreciate what this index is saying today.

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Clear Signs of SlowdownClear Signs of Slowdown

““Slower growth is clearly in the cards..””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, September 2007, September 2007

In September 2007 the WLI had weakened sufficiently for us to say:

“Slower growth is clearly in the cards.”

Two months later the message had shifted dramatically, and we wrote…

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Recession WarningRecession Warning

““The magnitude of oil and interest rate shocks arenear recessionary readings..””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, November 2007, November 2007

And we issued a clear Recession Warning noting that:

“The magnitude of oil and interest rate shocks are near recessionary readings.”

A month later, as we now know, the recession began.

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Here’s where that point in time is in terms of the WLI growth rate -- which had become the most negative since the 2001 recession (see red arrow).

And we wrote at the time…

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On the Cusp of RecessionOn the Cusp of Recession

““The breadth of deterioration evident in the latestdata on the components of ECRI’s many leadingindexes has rarely been seen except near the cuspof a recession..””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, December 2007, December 2007

That we were on the cusp of a new recession.

“The breadth of deterioration evident in the latest data on the components of ECRI’s many leading indexes has rarely been seen except near the cusp of a recession.”

This may be difficult to believe, but please recall that at this point in time the Fed was still pretty sanguine, and where the markets were expecting a 50bps rate cut surprised with only a 25bps cut. Clearly they hadn’t grasped the extent of the recession risk.

A month later in January 2008 we ratcheted up the alarm even further…

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A SelfA Self--Reinforcing DownturnReinforcing Downturn

““A self-reinforcing downturn has already begun. If allowed to continue, it will amount to the viciouscycle known as a business cycle recession. . ””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, January 2008, January 2008

We wrote that, “A self-reinforcing downturn has already begun.”

And by March 2008 we had clearly crossed the point of no return…

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““A Recession of ChoiceA Recession of Choice””

“(ECRI’s leading) indexes have unambiguouslyturned onto the recession track.”

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, March 2008, March 2008

Policy makers had acted in a so-called “bold” fashion, but they had done too little, too late to avert a recession.

As a result we were in what we called “a recession of choice” and we wrote: “(ECRI’s leading) indexes have unambiguously turned onto the recession track.”

Let’s step back for a second – a lot of people now believe that this whole nasty recession and financial crisis had tounfold roughly the way that it has. That is simply not true. I can discuss this later if you wish, but there were critical windows of opportunity during this sequence that could have headed off a recession for a while, not indefinitely.

Why is that important? Because resolving a credit crisis during a recession is very different from doing so outside of one.

Remember that we had a home price downturn for two years without any recession, but once a recession began, things were going to spiral out of control.

Specifically recessions mean job losses, which are bound to boost foreclosures, swelling the housing inventory and pushing home prices much more rapidly.

This in turn implied that the value of the credit derivatives was in free-fall because there was no end in sight to the now accelerating home price downturn.

The intensifying credit crisis rendered the Fed easing and fiscal stimulus virtually moot, with predictable results.

The funny thing was that the consensus believed we had dodged the recession bullet, and by June the markets at the instigation of the Fed had turned to worrying about inflation of all things.

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Here’s where the WLI stood at that time.

WLI growth less negative for sure, but still very much in a recessionary pattern.

So we wrote in June 2008 not just that we were in recession but that…

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No Recovery AheadNo Recovery Ahead

““A business cycle upturn remains in the realm ofwishful thinking. . ””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, June 2008, June 2008

“A business cycle upturn remains in the realm of wishful thinking. ”

But it was soon obvious to us that things were even worse based on our international leading indexes and in August 2008, before the Lehman collapse, mind you, we wrote:

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Global Recession at HandGlobal Recession at Hand

““We are now on the cusp of the worst global recession in nearly three decades..””

-- International Cyclical OutlookInternational Cyclical Outlook, August 2008, August 2008

That quote, “We are now on the cusp of the worst global recession in nearly three decades.”

This was our conclusion before the Lehman collapse.

Following the Lehman collapse it was obvious that things had turned much much worse, and we noted the grim near-term prospects…

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““Grim NearGrim Near--Term ProspectsTerm Prospects””

““TThere is no end in sight for this recession, making itlikely that the jobless rate will go substantiallyhigher..””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, October 2008, October 2008

Writing that “There is no end in sight for this recession, making it likely that the jobless rate will go substantially higher.”

Around this time Warren Buffet wrote a widely read op-ed exhorting Americans to buy the stock market, but by November we were saying…

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““Leading Indexes Fall Off a CliffLeading Indexes Fall Off a Cliff””

““There has hardly ever been such a swiftdeterioration of an already downbeat economicoutlook.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, November 2008, November 2008

“Leading Indexes Fall Off a Cliff”

As you might recall, three months later (in Feb) Mr. Buffet echoed our call, and declared that “the economy had fallen off a cliff.”

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““Leading Indexes Keep DroppingLeading Indexes Keep Dropping””

““There is no objective evidence to indicate that anend to this recession is anywhere in sight.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, December 2008, December 2008

In December things still looked bleak and we wrote that “There is no objective evidence to indicate that an end to this recession is anywhere in sight.”

But then our leading indexes began to stabilize and by March of 2009 we were able to make a growth rate cycle upturn call…

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Growth Rate Cycle Upturn ForecastGrowth Rate Cycle Upturn Forecast

““Upticks of the sizes already seen in the growthUpticks of the sizes already seen in the growthrates of the leading indexes rates of the leading indexes …… have always beenhave always beenfollowed by a growth rate cycle upturn.followed by a growth rate cycle upturn.””


A growth rate cycle upturn is a cyclical upturn in the RATE OF GROWTH of the economy.

And we wrote that “Upticks of the sizes already seen in the growth rates of the leading indexes … have always been followed by a growth rate cycle upturn.”

And why was this so important? Because…

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Importance of Second Derivative UpturnImportance of Second Derivative Upturn

““Historically, once a growth rate cycle upturnHistorically, once a growth rate cycle upturnstarted, a business cycle upturn began in zero tostarted, a business cycle upturn began in zero tofour months.four months.””


“Historically, once a growth rate cycle upturn started, a business cycle upturn began in zero to four months.”

This is what so many missed.

By April here’s where the WLI stood…

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See red arrow in April 2009

That is when we made our end of recession forecast.

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EndEnd--ofof--Recession ForecastRecession Forecast

““The recession will end this year, probably byThe recession will end this year, probably bysummer.summer.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, April 2009, April 2009

And we wrote “The recession will end this year, probably by summer.”

This was a very bold call at the time. Nouriel Roubini for instance was on a worldwide tour talking about a depression, having recently declared that the recession would not end until the end of 2010. Of course most people revise history very quickly.

But remember even economists looking at standard leading indexes didn’t have a leg to stand on if they were trying to predict the end of recession.

For instance, a few days after we had made our end of recession call, the Conference Board had the April release of its LEI, showing a bigger than expected decline, in fact the LEI had not shown a single monthly uptick since June 2008.

Over the next couple of months some came around to our view, but there was plenty of skepticism that helped trigger a June swoon in the stock market, but what were our leading indexes telling us?

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““Synchronized Surge in Leading IndexesSynchronized Surge in Leading Indexes””

““There are now pronounced, pervasive and persistent upturns in a succession of leading indexesof economic revival.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, June 2009, June 2009

Here’s what we wrote in June:

“Synchronized Surge in Leading Indexes”

“There are now pronounced, pervasive and persistent upturns in a succession of leading indexes of economic revival.”

Finally by August the consensus had begun to accept that the recession was over, but the pessimism lingered and people were expecting a weak “L” shaped recovery, or perhaps “W” shaped double dip.

And what were our objective leading indexes telling us? As we wrote a few weeks back…

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Strongest Recovery in DecadesStrongest Recovery in Decades

““Given the growing strength in ECRIGiven the growing strength in ECRI’’s objectives objectiveleading indexes, the odds are rising that at leastleading indexes, the odds are rising that at leastthe early stage of this economic recovery will be thethe early stage of this economic recovery will be thestrongest since the early 1980s.strongest since the early 1980s.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, August 2009, August 2009

“Given the growing strength in ECRI’s objective leading indexes, the odds are rising that at least the early stage of this economic recovery will be the strongest since the early 1980s.”

Now, some critics have said that it’s different this time. But they do not know that our work is rooted in the decades before the Great Depression. ECRI maintains a wide array of leading indexes for the U.S., including a Long Leading Index whose history goes back 90 years to 1919, and it has successfully navigated not just garden-variety post war recession, but also jungle variety depressions, crisis, and panics. They all support this outlook.

Despite everything that I’ve shared, I suspect that many of you will remain skeptical. So I would like to end reminding you of a couple things.

1. Everything that I’ve said here is based on objective leading indexes grounded in adeep understanding of the drivers of the business cycle.

2. These indexes have a very impressive track record.

But the real issue is that as human beings it is very hard to be upbeat after what we’ve been through…

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The Giant Error of PessimismThe Giant Error of Pessimism

““The error of optimism dies in the crisis but in dyingThe error of optimism dies in the crisis but in dyingit gives birth to an error of pessimism. This new errorit gives birth to an error of pessimism. This new erroris born, not an infant, but a giant.is born, not an infant, but a giant.””

-- U.S. Cyclical OutlookU.S. Cyclical Outlook, April 2009, April 2009

Early students of the business cycle knew that every crisis has its roots in what they called a “growing error of optimism.”

But here’s the point, in fact this is a quote from our predecessors in the 1920s.

“The error of optimism dies in the crisis but in dying it gives birth to an error of pessimism. This new error is born, not an infant, but a giant.”

That giant error of pessimism is still running rampant, and will keep most people mired in gloom, long after the Great Recession is history.

Thank you.

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