A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



V-Shaped Recovery... Maybe

In fact, the roar could blast your eardrums—at least according to two obscure economic indicators. The short conclusion: growth rates in U.S. gross domestic product could surpass an annualized 7%.

The two data points in question are the Weekly Leading Index from the New York-based Economic Cycle Research Institute, and the risk spreads on industrial corporate bonds. The readings on both metrics have some seriously bullish investment implications, in particular for retail stocks. But the results are so startling and counterintuitive that you need to know the thinking behind them.

First, let's look at the bond yields. Based on an analysis of corporate bond yields going back 60 years, David Ranson, head of research at HC Wainwright Economics, writes in a recent research paper: "A forecast of 7% growth rates should be conservative."

In particular, he focused on the percentage difference between the yields for the highest-quality bonds (those rated-Aaa) and lower-quality ones (those rated Baa, the lowest rank within the investment-grade category.)

Spreads indicate investor appetite for risky assets, explains Ranson. Higher spreads indicate lower appetite for risk, and vice versa. He observes that when those spreads narrow more than 0.4 percentage point, economic growth rates one and two quarters later exceed 7%.

But, and here's the kicker, "…the magnitude of recent events is beyond the range of variation in the past sixty years," he writes.

In other words, we've had such a dramatic drop in yield spreads recently that the jump in GDP growth should be truly massive, so don't rule out double-digit gains this quarter and next.

The other indicator is the growth rate in ECRI's Weekly Leading Index, which reached an all-time high in early October. That's based on data going back to 1968.

Lakshman Achuthan, managing director at ECRI, says growth in this recovery will be faster than in either of the last two expansions, but doesn't put a number on it.

ECRI has a great record of predicting both the beginning and end of recessions. It called the entry into this one in the fall of 2007 and the exit from this slowdown in the summer, long before anyone else had.

Achuthan says this will be a classic V-shaped recovery. The V-shape refers to the way the growth looks when plotted against time on a chart.

One of the major criticisms aimed at such bullish measures is that they merely reflect the massive monetary stimulus provided by the Federal Reserve and therefore are too narrow.

That could be leveled at Ranson's data, but not at ECRI.

The WLI data is proprietary so they don't tell us exactly what is in the soup.

But Anirvan Banerji, director of research at ECRI, does say: "All the key drivers of the business cycle have improved," and that "goes beyond monetary measures."

So what? Well, investors have already seen the classic early-cycle gains in some sectors of the stock market: Notably, huge rallies in commodity-related stocks and information technology.

What's next for big gains? Maybe retail.

"The consumer cannot be counted out," says Banerji.

And that surprising conclusion is shared by Wainwright's Ranson.