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Questioning The “Double Dip” Shibboleth




In a very short period of time, it has become almost unanimous consensus that the US economy is entering a "double dip" or a second recession before it has gotten a chance to recover from the previous one. This is a potentially dangerous situation because the monetary and fiscal policies have all been basically exhausted.

Beating the Business Cycle Achuthan BanerjiThe mentions of "double dip" are all over the media and Google trends shows that people are interested to know more as they search for this keyword on the internet. So we have a spike in attention and concern about this issue.

Whether this is a legitimate concern or not depends on who you ask. If you pay attention to bearish analysts like Albert Edwards of Societe Generale or David Rosenberg of Gluskin Sheff, then yes. But if you listen to the actual creators of the index and the authors of the book Beating the Business Cycle, you get a completely different perspective.

Since this came on everyone's radar a few weeks ago, Lakshman Achuthan has tried in different venues like CNBC to calm everyone down. Here is a video interview between Achuthan and Larry Kudlow, where he tries to set the record straight. The strain and frustration is even clearer in the more more meaty rebuttal written by the co-founders of ECRI to both the naysayers and the doomsayers, titled "ECRI WLI Widely Misunderstood". They conclude succinctly that,

A slowdown in U.S. economic growth is imminent, but a new recession is not.

If we ignore Achuthan and Banerji, we still have more than a few other reasons to not automatically conclude that the US economy is headed towards another recession. I already shared with you the Anxious Index, which has a very good track record. It is indicating an improving economy with no recession forecasted in the immediate future. As is MacroAdvisor's recession probability model.

Another argument is the relationship between the Leading (LEI) and Coincident Economic Indicators (CEI) from the Conference Board. These are competing indicators but provide a similar perspective. As you can see from the chart below, historically, when the LEI year-over-year momentum peaks and starts to turn down, the coincident indicators momentum turns positive, indicating that the economic recovery has taken hold. So while short term momentum may wane in the economy, it doesn't necessarily presage an imminent recession.

LEI compared to coincidence indicators Jun 2010
Source: Fidelity Investments

This is very similar to what Achuthan has been trying to communicate. Unfortunately, the creators of the indicator are being drowned out by analysts who have co-opted the indicator to argue for a "double dip" recession.

Recently Rosenberg shared this graph showing that when the ECRI's WLI is between -5% and -10% the next two quarters of GDP growth average +0.80% - hardly a recession:

GDP growth relative to ECRI WLI Jun 2010

Significant declines in the ECRI's WLI have predicted all but one of the recessions in the US since 1965. But also keep in mind that the WLI fell below zero 17 times without triggering a recession. Most of those were shallow negative incursions quickly followed by a recovery back above zero:

ECRI WLI long term chart Jun 2010

So it is a bit premature to interpret the current level of the ECRI's WLI as a definite harbinger of a "double dip" when we have not only its own history arrayed against such a knee-jerk reaction but also all the other indicators mentioned above. Of course, that could change if we see the WLI fall to lower levels or sustain itself under the zero line for a prolonged period of time. That may happen but as of yet, we do not have any indication - that I can find - of that scenario.

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2 Responses to “Questioning The “Double Dip” Shibboleth”  

  1. 1 Samuel

    There are other factors lending credence to the double dip scenario. One is the tremendous weakness in the housing market which tends to lead the broader private sector. We also appear to have a deflating private sector and flattening yield curve. So I'm not sure it is a knee jerk reaction. Though I think one should keep in mind of course that the WLI can follow along the 0 line. The private sector of the US economy does appear to be quite weak regardless of whether we officially go into recession or not.

  2. 2 OntheMoney

    I'd also add that the only time a dip in the ECRI growth rate to -5.8% (latest) did not lead to a recession was in 1987, at which time the Fed could and did quickly cut interest rates. And of course, being US growth indicators they do not reflect the overwhelming likelihood that (as Soros also believes) following major austerity measures the UK and Europe are headed for another recession in 2011.

    Another thing to bear in mind is that none of these leading indicators have been tested in a period of massive deleveraging and credit contraction such as we're currently seeing, nor in an era when the average age of the consumer is late 40s/early 50s (when spending naturally peaks) - over-levered consumers who have seen two huge bear markets knee-cap their investments and are now staring at retirement through a recessionary lens.

    This is a deep psychological shift, plainly evident in the flow of funds data which shows continuing flows out of equities and into bonds. That simply cannot support a further equity rally. I expect to see increased savings, lower consumption, low or falling GDP and deflating asset prices for a long time to come. Ultimately this will be healthy, but expecting it to be over in a couple of years is naive.

    Hope, therefore, is not to be relied on as a short-term investment strategy. Massive rallies such as we've seen are fantastic for traders but, as soemone much smarter than me once said, they're to be rented, not owned.

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