A major divergence has developed between various leading economic indicators in recent months.
The LEI, the government’s measure of leading economic indicators, has been steadily improving for months, suggesting that the U.S. economy is getting stronger and stronger. The stock market has been rising. December’s jobs numbers were encouraging. Rail shipments have been increasing. And so on.
Meanwhile, the economic forecasting firm ECRI (Economic Cycle Research Institute) has staked its reputation on an unequivocal recession call, observing that its own leading economic index, the WSI, remains firmly in negative territory. (For more on the divergence, read this.)
So who’s right?
We’ll know in six months.
In the meantime, fund manager (and PhD) John Hussman of the Hussman Funds has already declared a winner:
A recession remains “very likely,” Hussman concludes.
But what about all the positive economic data? The excellent surprises? The upturn since the scare of last summer? The December jobs report?
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All that is mostly noise, says Hussman. It’s not that it’s not good news. It’s just that it’s basically meaningless from a predictive point of view.Hussman has backtested all of the various “leading” indicators, and he has found that most of what are considered to be “leading” indicators are, in fact, either “concurrent” indicators (showing what the economy is doing NOW) or “lagging” indicators (showing what the economy WAS DOING recently).
Specifically, Hussman says, the reason the government’s LEI is likely giving a misleading growth signal is that half of its value is dependent on the size of the money supply, M2. M2 has been growing rapidly, but in recent years, with interest rates at zero, changes in the money supply have not been good predictors of economic activity. So Hussman thinks the LEI is telling the wrong story.
Since the purpose of a leading index is to predict rather than give a real-time or rear-view mirror view of the economy, Hussman continues to place his bets based on his own “ensemble” of leading indicators.
And this ensemble, Hussman says, continues to point to recession, probably beginning this quarter.