The Economic Cycle Research Institute ‘s (ECRI) leading indicator has to have been one of the most abused economic indicators of 2010.
As the ECRI indicator dipped around mid year, bears grabbed onto its decline as a sign of a coming double dip recession, even though the ECRI’s producers themselves made no such pronouncement. It didn’t help that high profile professionals such as David Rosenberg said, “we can safely say that this barometer is now signaling an 80% chance of a double-dip recession.”
Then when the ECRI began to rebound, bears were no longer interested in it.
This complete run around shows what a farce the ECRI has become, not due to its creators, but due to the hijacking of its analysis by others… who didn’t even know how the ECRI was calculated:
Rosenberg and Short are guilty of suggesting big conclusions without properly considering the underlying data. There are two specific problems:
1) The WLI index has an unknown composition. It is unwise to draw big conclusions when you do not understand the relationship. The WLI index itself is, by the design of the makers, a black box.
2) The growth component is some sort of smoothed annualized growth rate in the WLI. We do not know either the nature of the smoothing or the time period for the comparison.
Trying to draw inferences without knowing anything about the underlying data is crazy! It is much wiser to listen to the interpretation from those responsible for constructing and updating the index. How can anyone else think he knows enough to offer a better interpretation? Here is the ECRI interpretation (via Barry Ritholtz).
People were also overly focused on the ECRI’s growth index alone:
To elaborate further, let us look at the full published history of the ECRI data showing both series on the same chart.
The long-term growth in the WLI would not be apparent to those looking only at the growth index. It is deceptive to look at the growth index alone.
Again, just to make sure the situation is clear — the ECRI’s creators never said that the declining index was a recession signal
This ECRI debacle reminds us of another ‘leading economic indicator’ that roared to fame, during 2009, and was subsequently forgotten once its movements failed to confirm either the bulls or bears views anymore — the Baltic Dry Index (BDI) for dry bulk shipping.
Remember this one? Raymond James: Can the Baltic Dry Index Serve as A Leading Indicator of Oil Prices?’ Riiight…