Since we’ve discussed at length the reasons that this is an important low for the stock market, last week a reader asked me to give a bit more weight to the other side of the argument.
To do that we have to give turn our backs on technical indicators and give our attention to econometric indicators. Among these is the nervous attention lavished on the “double dip” scenario. At the beginning of the year we looked at the Google search trend for those dreaded words. Since the prevalence of searching for “double dip” gives us an indication of the sentiment out there, I thought we should update those charts.
Rather than just update the Google trends search results for “double dip”, I went a step further and compared its weekly results with the weekly Leading Indicator index from the ECRI for the past 12 month period:
We still see the two spikes from last year - the first in August 2009 and the second in November 2009. To understand the chart, I should explain that the Google Trends data is relatively scaled. This means that each point is presented relative to the average over the time period (12 months). So the most recent data point from last week at 3.38 means that searches for “double dip” last week were 3.38 times that of the average for the past 12 months.
The first spike, signaling an increase in concern about a weakening economy, happened last summer in August. When we compare it to the ECRI’s LEI we see that it was a considerable amount of worry for nothing. If we look at the year over year chart of the LEI we can see that the index was still expanding quite rapidly:
The second spike, showed that people had significantly more concern in mid-November 2009. This was more expected because it was a result of some weakening in the LEI. This brings us to today’s scenario.
The current spike easily surpasses the last one but it comes as a result of a total collapse in the LEI. In fact, we’ve never seen the ECRI LEI fall quite this rapidly.
To give you a bit of perspective to see the large decline better, here is a long term chart (courtesy of Societe Generale research) showing the year over year change in the ECRI’s Weekly Leading Index:
Considering the precipitous fall those dizzying heights, you would be forgiven if you expected all hell to break loose in sentiment. But all in all, our (flimsy) proxy for sentiment has not shown a concomitant rise.
Many are interpreting the deterioration in the LEI to have seriously negative portents. Societe Generale’s Albert Edwards says: “What differentiates this correction and the one we saw in February is that the leading indicators are unwinding this time around. That should leave us sceptical that any rally will persist for long.” Here is a recent video with Lakshman Achutha, the Managing Director of the Economic Cycle Research Institute:
One of the reasons why I pay attention to sentiment is that it is the feedback loop that winds and unwinds trends. More and more economists and analysts are recognizing this. Here is recent video of Prof. Robert J. Shiller speaking to Bloomberg on his view that a “double dip” recession could be a self-fulfilling prophecy. Since Shiller mentions consumer confidence, it is important to note that several indicators for it are showing a resurgence.
Finally, MacroAdvisers’s recession probability model is predicting that there won’t be a “double dip”
While ex post this model has a perfect record of predicting recessions, ex ante its predictions are only one factor we weigh when considering whether to introduce a double-dip recession into our baseline forecast. Still, the extremely low current reading is in notable contrast to readings during the early phase of the sub-prime crisis when the probability of recession flirted with 50% for a year before then finally rising strongly above that marker during the second half of 2007. At least by this measure, the economy appears to be in a less vulnerable position now than it was then.
Tune in tomorrow when I’ll share another important indicator which approaches the same question from a different angle.
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