Trader’s Narrative

The Survey of Professional Forecasters is little known or followed outside of econometric circles but it deserves more respect. Not because it is the oldest continuously calculated macro-economic prediction survey, but because it has an uncanny ability to predict both the start and end of recessions.

Now, I know, if you’re as cynical as me, you’re thinking, “But experts are hazardous to your financial health!” Yes, that is true. But there is wisdom in a crowd of prognosticators. With one caveat: as long as they toil away in obscurity and near anonymity. The more public their image and the higher their pay, the worse their predictions - yet another reason to ignore the chicklet-toothed “strategists” on CNBC.

The results are gathered and disseminated quarterly from the answers provided by a small group of about 40 handpicked experts. I use the term ‘expert’ because they all are required to produce forecasts as part of their normal jobs. The select group are academic, Wall St. economists, consulting firms, economists at multinationals, etc. But the one thing common to all of them is anonymity; ensuring that whatever the result, none of them can take claim for correct calls or be held accountable for terrible predictions. Although this may be appear as a disadvantage, it allows them to focus on the data. For some anonymity is liberating because it removes the potential stigma of not towing the party line (within their company or organization).

One specific survey question, referring to the probability of economic weakness has gained the most fame. This measure has come to be known by its nickname: “The Anxious Index”, given by David Leonhardt in his September 1st, 2002 article in the New York Times.

Alright, enough background. What does the data say? Here’s the chart showing the probability that GDP will fall in the following quarter:

Source: Federal Reserve Bank of Philadelphia

The recent data is the highest in the series. In the last quarter of 2008, the probability of a decline in GDP in the following quarter was 74.78% and in the first quarter of 2009 it was 73.98%. The next closest to this was back in the last quarter of 1974 (74.06%).

Interestingly enough, the probability for the present quarter experiencing a declining GDP was also the highest on record coming in at 90.14% and 94.41%. Basically the forecasters are saying, Duh? We are in a very deep recession! Why are you bothering to ask this silly question?

The Anxious Index foretells a recession when the probability of the next quarter experiencing a fall in GDP is 30% or more. You can see from the chart that it either coincides or predicts every single recession we’ve seen in the US. The most recent signal came in the first quarter of 2008 when the probability jumped to 42.91%. Of course, there were many other reasons why it was predictable at the start of 2008 that we were in a recession.

Similarly when it peaks and begins to come back down, it predicts that very soon, the economy will return to normalcy. Not immediately, but that the worst is over. The second quarter data for 2009 will be released in a little while and if it continues to head down or fall dramatically as is the pattern from previous recessions, then we have even more reason to believe that the worst is over.

Of course, that doesn’t mean that everything is suddenly peachy. It means that things stop getting worse at an accelerated rate. Then the next step is for them to plateau and then to rise.

I’ve focused on the predictions for GDP but the Forecast survey includes data on many other macro-economic variables. Follow the above link to the Philli Fed’s site and take a look around to discover more.

The Anxious Index from the Survey of Professional Forecasters seems to concur with the Index of Coincident Indicators and at the same time, manage to be one tiny step ahead:

Source: Recession, Far From Over, Already Setting Records

That isn’t surprising since the whole point of coincident indicators is to simply reflect the current situation while the Anxious Index attempts to predict the future economic situation.

So while the stock market is a forward discounting mechanism, here’s an interesting reason why, this time, the S&P 500 may actually lag GDP.

Last time I wrote about the beleaguered US dollar, it was just kissing its long term support at 80.

It managed to bounce (feebily) making it the sixth time to bounce off that support line. Alas, it seems there won’t be a seventh as the US dollar has managed to fall through to close around 79.

Take a careful look at this chart of the US dollar index:

Notice anything? It isn’t the recent chart. It is from 1992. Notice how it resembles our more contemporary US dollar index? The rally at the beginning of the year and then the fall into the summer? the fall through long term support?

Catch Up
Something else we have in common with 1992 is that the short term T-Bill rate had started to fall rapidly - ahead of the Fed funds rate. Then, as now, the Fed found itself in the all too familiar game of catch up and repeatedly lowered rates to match the rates set in the freely traded fixed income market.

So what happened to the dollar? Did it crash through the floor and go to zero? Did all hell break loose? Surely with the dollar so weak and the Fed reducing rates like mad, the currency market must have taken the dollar behind the tool shed.

Well, not quite. Here’s what happened next:

Although the similarities are remarkable between now and then, there really is no reason for history to repeat. As Twain quipped, history rhymes, not repeats exactly.

My point is that right now everyone expects the dollar to crash as the Fed lowers rates. But things seldom occur the way everyone believes they should. Popular “logic” has a tendency to be ignored by the market.

And if you recall macroeconomics 101, interest rates are important but there are a few more variables that go into the valuation of currencies. I have no idea whether we’ll see the 1992 rally repeat, but frankly, it wouldn’t surprise me.

Here’s a recent weekly chart for comparison: