Is ECRI changing its story on predicting a US recession?
I have Bloomberg copy and a video of a recent performance by ECRI’s Lakshman Achuthan on Tom Keene’s show. A lot of people have been pouring scorn on business cycle forecaster Achuthan because of his company’s recession forecast. I suspect most of it is driven by bulls annoyed by his downbeat forecast or by the media’s instinct for gotcha with prognosticators.
ECRI claims to be able to call recessions in real-time, generally before they actually happen. Why is this important? Well, as I put it in 2008 regarding "reliance on recession as the key measure of economic difficulty":
In fact, recession is a lagging indicator which is completely useless for planning purposes because most of the damage to the economy and your portfolio is done by the time recession hits. In the future, we need to look for reliable early signs of weakening economic activity if we want to avoid getting caught in the headlights of a recession.
Bottom line: Large businesses and institutional investors need to have lead time for capital allocation strategies. Waiting until recession is on top of you to react means getting caught out and then shifting at lightning speed in hopes that you don’t underperform. For individuals and retail investors it’s different.
Now, the issue with ECRI is twofold:
- Are they accurate: meaning do they make good forecasts that one can reliably use as a business or investment planning tool?
- What are the data points they use to make those predictions? Some people feel uneasy about their forecasts and others speculate about what the components of the ECRI’s indices are.
I have gone back into my archives to see what ECRI was saying last year since it has been predicting recession since September. My point basically was to find out what Achuthan specifically said about when and how the recession he says is now happening would occur. What I found over and over again was that he never gave a specific date in September, October and November. Rather Achuthan said pointedly starting in August that irrespective of policy initiatives, certain cyclical elements of the business cycle were already locked in a specific trajectory. As Achuthan put it in October 2011, "once the feedback loop starts, it’s more powerful than any policy response.” Achuthan believes policymakers can only make the situation worse at that point.
For example, in August Achuthan began saying “it’s too late” for Obama on Jobs, meaning that the die was caste cyclically. By September, Achuthan was forecasting recession, meaning that the trajectory toward recession was locked down, not that recession was imminent. This is the key to deciding how ‘accurate’ Achuthan has been. It’s in how you interpret what his forecast is all about.
I said in my 2008 post on business cycles that:
- Year-over-year rates of change are the critical factor. Don’t look at the absolute levels, focus in on the change — the delta, if you will.
- Consumer spending makes up two-thirds of the economy and drives the rate of economic change more than any other variable. Therefore, predicting key turning points in consumer spending patterns is going to be critical. [Former retail analyst Joseph] Ellis says doing this will generally also predict turning points in the economy as a whole. The sequence goes: consumers’ real hourly earnings to consumer spending to industrial production to capital spending to corporate profits.
So the point of a recession forecast is to predict when the negative feedback loop between lower consumer spending, retail sales, production and employment makes a recession unavoidable.
My read of what Achuthan is doing is through this lens. So when I hear him making a recession call, I’m thinking he is looking at the rates of change in leading economic indicators and making a forecast as to when they have begun this negative feedback loop. It works the same way for a recovery except in reverse. Anyway, that’s my piece. I don’t think Achuthan is changing his story in the least. At some point, Achuthan started to say recession as early as Q1, something he admits below. You can listen to Achuthan and figure out how accurate he is by looking at the articles tagged ‘ECRI‘. As for what’s in Achuthan’s ‘model’, I have no idea. But if you are a sophisticated investor or business, you don’t need to know because the ECRI business cycle stuff is just one arrow in your quiver. Betting the farm solely on ECRI’s black box doesn’t make good business sense.
And, from where I sit, this would qualify as a double dip, if it is a recession.
Bloomberg Television copy and video below.
Achuthan on whether he can reaffirm his recession call from last year:
“Yeah…I think a lot of people forget what our call was. What we said back in December was that the most likely start date for the recession would be in Q1 and if not then, by the middle of 2012. I’m here to reaffirm that. I think we’re in a recession. I think we’re in a recession already. As I said back there, it is very rare that you know you’re going into recession when you’re going into recession. It often takes some big hit on top of the head. In the last recession, it took Lehman to wake people up and the recession before, it took 9/11.”
On how ECRI defines recession:
“It is not our definition. It is the definition of what a business cycle is, which was established by my mentor Jeffrey Moore’s mentor Wesley Mitchell back in the 1920s. What is a recession? It is not a statistic; it is a process between production, employment, income and sales. When you look at those four measures, they are rolling over.”
“It is not all about GDP. It is about jobs. It is about income and sales. A recession is a vicious interplay among output input employment, income and sales. When you look at 2001, you can’t find two negative quarters in a row, yet you lost 3 million jobs. Or half the value of the NASDAQ. How are you going to tell someone that wasn’t a recession? When you look at the data today, you see that industrial production is off of its April high. Manufacturing and trade sales, much broader than retail sales, is off its December high. Real personal income growth, which does not always go negative during a recession, has been negative for several months so it is consistent with a recession having already started.”
On what the relative optimists get wrong in economics today:
“I think there is this belief that somehow government or a central bank will stave off a recession. For the last 220 years, you do some history with Hamilton, which ended in a duel by the way…you have had 47 recessions. Why are we going to avoid the 48th? Here we are in the wake three years out of the last recession. You see this leading indicator. It leads, it is the drivers of the business cycle and it is doing this bumping down. People look it that and they say, each time they throw in some money or do something, you get less for it. I am surprised given the trillions of dollars spent around the world that that indicator is as weak as it is. That is a recessionary reading.”
On why the U.S. is struggling:
“We have entered these so-called yo-yo years. We have been seeing weaker and weaker expansion since the mid 1970s. We have not been freaked out by it because the business cycle has been pretty mellow over the last 20-25 years. Until now. So if you have a more volatile business cycle and low growth, you get more recessions and you start to destroy people’s ability to earn. In particular, when we talked slower expansion, we’re not talking GDP, we’re talking jobs, too. In particular you’re seeing no jobs growth.”
On how globalization plays into indicators:
“There’s a lot of things in there. Globalization is part of it. There’s a lot of one offs that have occurred in the last decade. The falling of the iron curtain. The emergence of China and India. A lot of productivity growth. A lot of aging of the population. So there is a lot of a factors in here at work. But when you are competing, as we are globally, companies are trying to squeeze their costs. People are a big part of that. What you see is what is alarming right now, people that are in their prime earning years, which is roughly from 35 to 54, over the last two years, they have lost jobs. Net jobs have been lost for that cohort of the American job market and that is when you’re supposed to make your money.”
Source: Bloomberg Television