Written by Steven Hansen
Our June 2013 Economic Forecast continues to say the economy will be expanding at a modest rate. The concern is that many portions of our economic model are barely positive, and even a small black swan could cause contraction. On the other hand, the portions of our model which are negative are barely negative, and there are white swans too.
We warned last month that consumer spending increases continued to grow at a much faster pace than income – and that eventually either a jump in income or a fall in consumption must occur to close this gap. This remains an economic headwind as the economy heads into 3Q2013.
- Main Street does not have the sectors in sync – and as one strengthens, another starts a weakening cycle. This seems to be the reason why an improving rate of economic growth is not taking hold.
- Econintersect checks its forecast using several alternate methods. All of our check methods are positive.
- Note that literally all the graphics in this post auto-update. The words are fixed on the day of publishing, and therefore you might note a conflict between the words and the graphs due to backward data revisions and new data which occurs during the month.
This post will summarize the:
- leading indicators,
- predictive portions of coincident indicators,
- review of the technical recession indicators, and
- interpretation of our own index – Econintersect Economic Index (EEI) – which is built of mostly non-monetary “things” that have been shown to be indicative of direction of the Main Street economy at least 30 days in the future.
- the consumer is still consuming. However, it is concerning that the consumer is spending so much of its income. This continues to suggest there may be some pullback in the coming months in consumer spending. The index is currently marginally below 0.94. This year (2013) is only the third period in history where the ratio has exceeded 0.94 (end of 2001 recession, the calendar year 2005, and now).
Seasonally Adjusted Spending’s Ratio to Income (a declining ratio means Consumer is spending less of Income)
- The St. Louis Fed produces a Smoothed U.S. Recession Probabilities Chart which is currently giving no indication of a recession.
Smoothed recession probabilities for the United States are obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales. This model was originally developed in Chauvet, M., “An Economic Characterization of Business Cycle Dynamics with Factor Structure and Regime Switching,” International Economic Review, 1998, 39, 969-996. (http://faculty.ucr.edu/~chauvet/ier.pdf)
- Joe Sixpack’s economic position is strengthening. This Econintersect index’s underlying principle is to estimate how well off Joe feels. The index was documented at the bottom of the July 2012 forecast. Joe and his richer friends are the economic drivers. Joe is the blue line in the graph below, and that is not close to the levels associated with past recessions. Note this index is updated every quarter.
Joe Sixpack Index (blue line, left axis)
- Econintersect reviews the relationship between the year-over-year growth rate of non-farm private employment and the year-over-year real growth rate of retail sales. The index has been flirting with the zero growth line – and there is no obvious short term trend. As long as retail sales grows faster than the rate of employment gains (above zero on the below graph) – a recession is not imminent.
Growth Relationship Between Retail Sales and Non-Farm Private Employment – Above zero represents economic expansion
- Most economic releases are based on seasonally adjusted data which is revised for months after issuance so a contraction in a particular release may not be obvious for many months.
The Leading Indicators
The leading indicators are monetary based to a large extent. Econintersect‘s primary worry in using monetary based methodologies to forecast the economy is the current extraordinary monetary policy which may (or may not) be affecting historical relationships.
Econintersect does not use data from any of the leading indicators in its economic index. All leading indices in this post look ahead six months – and are all subject to backward revision.
ECRI’s Weekly Leading Index (WLI) – Econintersect is now ignoring ECRI’s recession call as it is obvious it is no longer relevant. ECRI’s WLI index value is now solidly above zero which according to their definition means the economy six month from today will be better than today. A positive number shows an expansion of the business economy, while a negative number is contraction. This index was on an improving trend for 2012, but in 2013 the trend growth rate is flat.
Current ECRI WLI Index
The Conference Board’s Leading Economic Indicator (LEI) – Looking at historical relationships, this index’s 3 month rate of change must be in negative territory many months (6 or more) before a recession occurred. In mid-2012, the rate-of-change made several small incursions into negative territory – but is currently in positive territory implying any recession is months away.
Leading Index for the United States from the Philadelphia Fed – This index is the super index for all the state indices.
The leading index for each state predicts the six-month growth rate of the state’s coincident index. In addition to the coincident index, the models include other variables that lead the economy: state-level housing permits (1 to 4 units), state initial unemployment insurance claims, delivery times from the Institute for Supply Management (ISM) manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury bill.
Nonfinancial leverage subindex of the National Financial Conditions Index – a weekly index produced by the Chicago Fed signals both the onset and duration of financial crises and their accompanying recessions. Econintersect believes this index, when used with other indices – provides a viable tool for forecasting the economy six months in advance. As this index is relatively new, its real time performance is suspect as it is subject to backward revision. The chart below shows the current index values, and a recession can occur months to years following the dotted line below crossing above the zero line.
Leading Indicators Bottom Line – no recession in the next six months:
- ECRI’s WLI is clearly positive.
- The Conference Board (LEI) is indicating modest growth over the next 6 months.
- The Philly Fed’s Leading Index is indicating economic growth.
- The Chicago Fed’s ANFCI is not close to warning a recession could be near.
Forward Looking Coincident Indicators
Here is a run through of the most economically predictive coincident indices which Econintersect believes can give up to a six month warning of an impending recession – and do not have a history of producing false warnings. Econintersect does not use any of these indicators in its economic forecast.
Consider that every recession has different characteristics – and a particular index may not contract during a recession, or start contracting after the recession is already underway.
Truck transport portion of employment – to search for impending recessions. Look at the year-over-year zero growth line. For the last two recessions it has offered a six month warning of an impending recession with no false warnings. Transport is an economic warning indicator because it moves goods well before final retail sales occur. Until people stop eating or buying goods, transport will remain one of the primary economic pulse points.
Transport employment growth is far above the zero growth line. As transport provides a six month recession warning – the implication is that any possible recession is further than six months away.
Business Activity sub-index of ISM Non-Manufacturing – this index is noisy. Currently it appears a downward trend is in play. The index is barely above 55 (below 55 is a warning that a recession might occur, whilst below 50 is almost proof a recession is underway).
Predictive Coincident Index Bottom Line – no recession indications.
- True economic activity (not monetary based GDP) was expanding in the most recent hard economic data somewhere below 2% plus in many sectors of the economy using non-monetary pulse points based on these indices shown above, and other indices which Econintersect are indicative of the real economy.
- Overall the coincident data seems stable.
Technical Requirements of a Recession
Sticking to the current technical recession criteria used by the NBER:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.
….. The committee places particular emphasis on two monthly measures of activity across the entire economy: (1) personal income less transfer payments, in real terms and (2) employment. In addition, we refer to two indicators with coverage primarily of manufacturing and goods: (3) industrial production and (4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.
Below is a graph looking at the month-over-month change (note that multipliers have been used to make changes more obvious).
Month-over-Month Growth Personal Income less transfer payments (blue line), Employment (red line), Industrial Production (green line), Business Sales (orange line)
In the above graph, if a line falls below the 0 (black line) – that sector is contracting from the previous month. At his point, only industrial production is in the warning zone. Again, this is a rear view mirror, is subject to revision, and is not predictive of where the economy is going. Another way to look at the same data sets is in the graph below which uses indexed real values from the trough of the Great Recession.
Indexed Growth Personal Income less transfer payments (red line), Employment (green line), Industrial Production (blue line), Business Sales (orange line)
NBER Recession Marker Bottom Line – no recession markers although industrial production is struggling.
Econintersect believes that the New Normal economy has different dynamics than most economic models.
Economic Forecast Data
The Econintersect Economic Index (EEI) is designed to spot Main Street and business economic turning points. This forecast is based on the index’s three month moving average. The three month rolling index value has declined marginally three months in a row.
The EEI is a non-monetary based economic index which counts “things” that have shown to be indicative of direction of the Main Street economy at least 30 days in the future. Note that the Econintersect Economic Index is not constructed to mimic GDP (although there are correlations, but the turning points may be different), and tries to model the economic rate of change seen by business and Main Street. The vast majority of this index uses data not subject to backward revision.
Econintersect Economic Index (EEI) with a 3 Month Moving Average (red line)
The red line on the EEI is the 3 month moving average which is at 0.31 (down from last month’s 0.35), while the monthly index improved from 0.4 to 0.5. The economic forecast is based on the 3 month moving average as the monthly index is very noisy. Readings below 0.4 indicate a weak economy, while readings below 0.0 indicate contraction.
A positive value of the index represents main street economic expansion. If the economy was growing at the same rate, this index would return a value of 0.50. This month’s value of 0.31 shows the main street economy’s relative rate of growth is marginally weaker than last month.
Consumer and business behavior (which is the basis of the EEI) either lead or follow old fashion industrial age measures such as GDP depending on the dynamic which is driving the economy. The main street sector of the economy lagged GDP in entering and exiting the 2007 Great Recession.
As Econintersect continues to back check its model, from time-to-time slight adjustments are made to the data sets and methodology to align it with the actual coincident data. To date, when any realignment was done, there have been no changes for trend lines or recession indications. Most changes to date were to remove data sets which had unacceptable backward revisions or were discontinued. Documentation for this index was in the October 2011 forecast.
Jobs Growth Forecast Improves
The Econintersect Jobs Index is forecasting non-farm private jobs growth of 155,000 – up from last month’s 145,000. The fundamentals which lead jobs growth have been strengthening.
Comparing BLS Non-Farm Employment YoY Improvement (blue line, left axis) with Econintersect Employment Index (red line, left axis) and The Conference Board ETI (yellow line, right axis)
The Econintersect Jobs Index is based on economic elements which create jobs, and (explanation here) measures the historical dynamics which lead to the creation of jobs. It measures general factors, but it is not precise (quantitatively) as many specific factors influence the exact timing of hiring. This index should be thought of as a measurement of jobs creation pressures.
At the present time, jobs growth year-over-year (green line in below graph) is averaging above the levels forecast by the Econintersect’s Jobs Index (blue line in below graph).
Econintersect Employment Forecast (blue line), Fudged Forecast* (red line), and BLS Non-Farm Jobs Month-over-Month Growth (green line)
* fudged growth (red line in above graph) based on deviation between forecast & current actual using a 3 month rolling average
A fudge factor (based on deviation between the BLS actual growth and the Econintersect Employment Index over the last 3 months – red line in above graph) would project jobs growth at 222,000. The fudge factor is fluid as the BLS has significant backward revision to their jobs numbers.
Analysis of Economic Indicators:
Econintersect analyzes all major economic indicators. The table below contains hyperlinks to posts. The right column “Predictive” means this particular indicator has a leading component (usually other then the index itself) – in other words has a good correlation to future economic conditions.