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US recession, vicious cycle

Is the sky really falling? In a business far more forgiving of misguided optimism than the opposite, pundits must be wary of predicting recessions. They are, after all, fairly rare, with just 11 in the US since the second world war. Still, enough economists are willing to stick their necks out at times like this for one economist’s quip about having predicted nine out of the past five recessions to remain relevant.

To its credit, the Economic Cycle Research Institute is no Chicken Little. A little over a year ago, when numerous commentators seized on an alarming decline in its weekly leading indicator to predict a contraction, the institute loudly (and it turns out correctly) harrumphed its disagreement. Yet now that the WLI is again pointing down, though less sharply than a year ago, the institute has made an unambiguous US recession call. The fact that the institute not only failed to sound a false alarm in 2010 but started seeing evidence of this downturn before Japan’s earthquake, and forsesaw a severe one in 2008 before Lehman’s collapse, show just how leading the institute’s leading indicators are.

Though eyeballing a long-term chart of the WLI shows it to be a nearly infallible harbinger of contraction, there are a lot more tools in the institute's proprietary box that go into such calls, and they are now uniformly negative. Perhaps more alarmingly, it sees more frequent recessions in the future than the relatively calm recent decades. So, while an abrupt end to the current two-year expansion appears premature, it would not be in a longer historical context.

But past is not prologue. Because its predictive techniques are opaque, investors are forced to take the institute on faith, leaving open the possibility they are relying on the “wrong” data – garbage in, garbage out, as they say in the prediction business. All the same, this is one recession prediction that Wall Street’s normally panglossian majority will find it hard to rubbish.

Link to article on FT Lex column website.

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