While we trade the “recession waiting game” and make profits on the swings of optimism and pessimism, we can also look at solid research with strong forecasting capability.
Some of the most respected such forecasting comes from the Economic Cycle Research Institute headed by Lakshman Achuthan. His work has correctly predicted several recessions and recoveries (I’m not sure of his exact batting record, but his work is widely respected for its quantitative rigor and prediction ability).
I saw him on CNBC Wednesday morning before the Challenger and ADP jobs numbers and he was not very optimistic. Wait, that sounded lame and watered down — truth is, he was pretty pessimistic.
My apologies for not telling you this yesterday. I just forgot to squeeze it into my column. As an aside here, wait until Zacks launches its new interactive feature “Real-Time Insight” where I can fire off good pieces of info, tradable news, and links like this immediately, ala Twitter style, and you can respond to them on the site.
ECRI: We See a Trend of Continuing Pain
I went to the ECRI website and also watched another, and better, interview with Lakshman on Yahoo! Finance with Aaron Task from this past Monday August 29. Allow me to summarize some key themes from his views, using both interviews…
The cyclical slowdown that he predicted in mid-May has been confirmed and there has been no up-turn in the data to suggest the trend will reverse anytime soon. Incidentally, remember yours truly said on May 31 with the S&P at 1,345 that the stock market would go sideways to lower for the summer as it absorbed new slowdown data points. And I reiterated that call on June 30 even after the drop to 1,260 and rally back to 1,320.
A “cycle-based” slowdown is a big deal. He uses words like “pronounced, pervasive, persistent.”
That said, he can’t confirm we are headed into recession yet. The jury is still out. Key take away: his leading indicators are pointing toward recession and seem to have momentum in that direction.
Given this new trend with its own momentum, Lakshman believes government stimulus can do very little to help, much less prevent a recession. On CNBC, when asked about Obama’s jobs initiative that we expect to hear about next week, he said that this might have helped if it were implemented six months. Nothing we hear next week will change the cycle in the near term.
While he acknowledges the importance that both consumer and investor confidence play in the business cycle — and the negative feedback loop that can be created during a market or economic downturn — he doesn’t see a “self-fulfilling” recession being created as I have written about often.
Here’s how he sees the feedback loop working: Weak sales cause a drop in production, which reduces employment, which hits confidence and incomes, which comes back to dent sales further.
Oddsmaking for the Probable Recession
He’s not too crazy about strategists, like me, assigning probabilities to recession scenarios. In fact, he calls it “dangerous” because it offers an “illusion of precision.” He prefers the objective analysis of significant “forward-looking” data about spending, inventories, sales, employment, and profits growth.
In my defense, I am a trader who take positions based on odds and risk, and weighting ideas and trades with probability-based thinking helps me gauge my risk, my potential reward, and thus my position sizes.
Impacts from Hurricane Irene, and other bigger disasters like the earthquake in Japan, tend to show up as “noise” in the data, a temporary blip if you will. The cyclical downturn is a much bigger, and persistent, trend.
Slow growth muddle-through scenario? Lakshman says that works sometimes when you have a mellow, moderately-ascending economy, not a highly-turbulent one. We are in high turbulence now.
Expansions are becoming shorter. We are in an era of more frequent recessions, where unemployment rates will spike and tax receipts will fall. There are big structural issues plaguing our economy — in fact the entire global economy — that are even bigger than this downturn.
He gave an example of the Chinese company which manufacturers iPads replacing workers with robots. This is something I talked about in the last Zacks Roundtable, explaining why technology and cheap labor overseas will keep the US “employment-to-population” ratio below 60% and shrinking. Obama’s new jobs czar, Alan Krueger, is focused on this number too.
A Bear With Some Money On the Line
Last week, I saw an investment manager on Bloomberg TV talk about his recession forecast. Komal Sri-Kumar of TCW oversees the global management of about $120 billion. He thinks 3rd quarter GDP will come in at -1% and -2% for the 4th quarter.
Some are waiting for ECRI’s Lakshman to say “the recession is coming!” Others are making their own probability-based predictions with real money. I’m watching and listening to them both.
Kevin Cook is a Senior Stock Strategist with Zacks.com
Zacks Investment Research
