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Should We Be More Worried About A “Double Dip”? at Trader’s Narrative





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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:
ECRI leading indicator compared to google trends double dip Jun 2010

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:

ECRI yoy change compared to google trends double dip Jun 2010

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:

US ECRI long term chart Jun 2010

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”
MacroAdvisors recession probability model May 2010

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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7 Responses to “Should We Be More Worried About A “Double Dip”?”  

  1. 1 BO

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    ECRI growth rate that decline to zero no longer means recession ahead. This article can explain that fact.

  2. 2 Babak

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    Thanks BO, yes the ECRI’s LEI is not really a great tool to time the market. Here’s a recent CXO post on the correlation or lack thereof. Also something easily overlooked is that one of the ingredients in the Weekly Leading Index is the stock market performance! so if the market falls, of course that is going to drag the WLI down.

  3. 3 doug

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    not as concerned about the level as with the rapid decline, can anyone come up with an economic scenario where it reverts to the upside? stimylus is ending. M3 declining, tax increases an china trying to slow growth.

  4. 4 Streetcar

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    Doug - Good results from the second quarter may reverse the down trend. However, I’d only use it as a short term trade.

    As double dip is growing into an old school term, I am thinking about another scenario — a triple dip, or a quadruple dip, a multi-year aneamic period within a trading range like the one between 1965 - 1982.

    If it is true, it’d be a paradise for traders, but a hell for buy-and-hold investors.

  5. 5 WimpyInvestor

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    Good to finally see someone else use the 1966-1982 Playbook. My own observation using notice technical analysis is that the SPY performance from March 2009 to May 2010 has matched up quite nicely with the Sept 1974 to Oct 1975 period. Even the current correction from April to May 2010 matches up with the pullback in late 1975.

    This scenarios has SPY peaking at around $120 or $130 (higher if using 66% Fib retracement, lower if using 61.8% retracement), but perhaps the timing of the intermediate term peak is more important (as compared to the final price level).

    Should this scenario continue to play out, SPY could peak around June 2011 (corresponding to Dec 1976), so those playing the market from the short side (hoping for an economic double-dip or bigger collapse) could be hurt for some time.

    In the range bound environmnent, harvesting dividend yield and call premium using covered-call strategy could produce the best risk-adjusted results. VIX trading from 15 to 48 so far in 2010 has created tremendous trading opportunities for those willing to be open-minded with regards the the letter shape of the economy (V, W, L, U, or Square-Root).

  6. 6 Kristjan

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    BO and Babak,
    thanks for the links in the comments. The CXO on is particularly interesting.

  7. 7 oexrex

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    WI

    I am neither an emotional Bull/Bear, I simply look at the technicals of the market. In the past 19 mos comparisons have been made to the early 30’s, ‘73-’75, and recently ‘62 and last week in Santolli’s column ‘50.

    I do have an “expectation” over the next 1 - 2 months but that remains to be seen on the technicals at that time.

    That said there are significant differences between present conditions, and ‘73 - ‘75 or even ‘04.

    I think ASSUMEing that the market will ‘rhyme’ could prove painful.

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