Using the stock market to predict the economy doesn’t work
Investors are rightly concerned about the effects of a double-dip recession on the stock market. If the feared double-dip were to occur stocks prices would plunge, even from today’s fairly cheap levels.
So the question we, and other investors need to get right is this: has the economy slipped back into a recession or is this simply a period of slower growth following the initial burst of growth in the second half of 2009?
We side with those arguing for a slowdown and therefore we think the current weakness in stocks is another correction in a bull market rather than the beginning of the next bear market.
But things change quickly, so we need to watch indicators that would signal that we are wrong in our current optimistic stance. Below we present one simple index to watch (Leading Economic Indicators Index), but we also attach a recent piece produced by the team at Bank Credit Analyst, which should give us an early warning if the feared double-dip is upon us.
First, the Leading Economic Indicators Index (LEI). The chart below shows 50 years of the index and all the recessions since 1958. Every recession was preceded by the LEI dropping below the zero line. There have been a few false alarms, but importantly, no missed recessions. The current reading is far above the level that would signal a recession.
This chart also shows the one double-dip recession since the Great Depression. That occurred in 1981 when Paul Volker took the Fed Funds rate above 10%. Nothing like that is in the cards today.
In addition to watching this important index we will be tuned into Bank Credit Analyst and the Recession Model they just developed. It uses 8 different indicators in an attempt to provide an early warning system for recessions. The full document explaining how it works is attached to this email.
Right now the Recession Model says the chance of recession returning in the next few months is about zero.
Of course for those who believe we are still in a recession because of the tragically high unemployment rate, all this is academic. But as investors we need to stay focused on profits rather than the jobless rate. If profits continue to move up, so will stocks, even if unemployment remains high.
We wish the economy were strong enough to produce both profits and jobs, but for reasons we’ve outlined in the past, that’s not the world we live in at the moment.
Best regards,
Daniel A. Ogden
