The index is “designed to track real business conditions” based on six indicators that are a blend of high and low frequency data, i.e., economic reports with frequent and relatively infrequent updates. The latest reading, however, shows an upturn, suggesting perhaps that the slump of late is about to turn.

One clue that the upturn may have legs comes by way the latest outlook for the Philly Fed's region, where the "manufacturing sector is continuing to show signs of growth," according to the current update.

In the wake of the Philly Fed manufacturing news, Bloomberg News advises:

Factories keep adding workers and increasing production to replenish depleted inventories and meet rising global demand. Gains in manufacturing may be the spark that ignites a broader economic expansion, leading to increases in payrolls and consumer spending.

“The manufacturing sector has been the one bright spot for the economy in recent months,” said Scott Brown, chief economist at Raymond James Associates Inc. in St. Petersburg, Florida. “Clearly a sustainable recovery will require an improvement in the jobs. We’re right on the cusp of new hiring.”

Meanwhile, the Conference Board today reported that its leading economic indicator (LEI) rose last month--the 11th consecutive increase. “The LEI for the U.S. has risen rapidly for almost a year now and it has reached its highest level," Ataman Ozyildirim, an economist at The Conference Board But, said in an accompanying press release. "The sharp pick up in the LEI appears to be stabilizing. As the economy moves from recovery into early phases of an expansion, the leading economic index points to moderately improving economic conditions in the near term. Correspondingly, the coincident economic index has been rising since July 2009, albeit slightly because of continued weakness in employment."

Another dismal scientist at The Conference Board said: “The indicators point to a slow recovery this summer." In the near term future, advised Ken Goldstein, "the big question remains the strength of demand. Without increased consumer demand, job growth will likely be minimal over the next few months."

The opportunity for fresh data supporting (or rejecting) optimism arrives next week with updates on durable goods orders (Wed), weekly jobless claims (Thursday) and the final estimate of 2009 Q4 GDP (Friday).

The clock is still ticking for a more convincing rebound, particularly with the labor market, which remains weak. But the clock is ticking slower than it otherwise would be if inflation was a threat, which it isn't, at least not based on the latest reading via today's CPI report, as we noted earlier.

"Tame inflation is the get-out-of-jail-free card for the Fed," opines Lou Brien, market strategist at DRW Trading via Reuters. Why does the bell toll for thee in slow motion? "Because as long as inflation stays low or trends lower as it's doing," he says, the Fed "can wait for the labor market to come back longer than they would if inflation was to start trending up." In short, the monetary liquidity flowing can roll on without worry of pricing pressures.

But the ticking may soon pick up the pace, as The Economist yesterday reported:

Dave Greenlaw of Morgan Stanley notes that one component explains all the decline in core inflation: housing. America’s Bureau of Labour Statistics measures the cost of home ownership by what someone would have to pay in order to rent the house he owns. Falling home prices and high vacancy rates are pushing rents down. Since rent and the estimated equivalent of rent for owners comprise more than 40% of the core index, this has a huge impact on the direction of core inflation. When housing costs are excluded, core inflation has actually risen, to 2.6% in February. Mr Greenlaw predicts that housing inflation will stop falling, spurring the Fed to raise rates later this year.

Maybe, although as Paul Ashworth of Capital Economics also tells The Economist, the weak labor market is the source of the feeble housing market. Unless you expect to see the labor market turn much stronger in the near term, the get-out-of-jail-free card will likely remain intact.

It's still all about jobs (politically and otherwise), and probably will be for many weeks and months to come.

Meanwhile, inflation remains subdued, based on today's inflation report. The consumer price index last month was unchanged from January, the Bureau of Labor Statistics advises. For the past 12 months, CPI inflation rose at a modest 2.1%.

Last month, the inflation report raised fresh concerns that deflation was again building a head of steam. In particular, core CPI (headline inflation less food and energy prices) slipped a bit in February. That was the first monthly decline in seasonally adjusted core CPI since 1982. A whiff of deflation, in other words, was in the air—again, as we wrote last month. In the wake of today's update, there's reason to think that last month's bout of deflation was an anomaly. Still, with prices overall edging up by the thinnest of margins, it's too soon to make definitive judgments one way or the other.

So it goes in evaluating current and future economic trends. With the great rebound from the abyss in late-2008 and early 2009 behind us, the heavy lifting of rebuilding the economy is upon us. Dramatic change, good or bad, seems unlikely for the foreseeable future. Instead, the back and forth of marginal adjustment may be with us for some time. The economy is struggling to pull free from a sea of debt on the balance sheets of government, businesses and consumers. On the plus side, monetary/fiscal stimulus, supported by the natural forces of cyclical recovery, is fighting the good fight.

We expect the forces of expansion to win, but the evidence of this triumph will come slowly, at times giving way to frustrating bouts of reversal. We've already seen this to some extent in jobless claims this year, as well as with consumer price. More of this backtracking is likely coming on various fronts.

Nonetheless, there are accumulating signs that the tipping point of expansion is near. It's going to be a struggle, to be sure. And much still depends on the labor market. Maybe the arrival of spring will be a catalyst. Heck, the economic cycle needs all the help it can get at this point.

A bit of good luck wouldn't hurt either. A surprisingly good report on the job front in the weeks and months ahead might just be the spark that gets us over the hump. Unfortunately, a negative surprise might bring the opposite. It's still precarious out there. Look out for falling shoes. But don't give up hope just yet.

No wonder, then, that here’s a lot riding on the outlook for equity returns above and beyond the risk-free rate, which we can define as short-term Treasury bills or, if you prefer, the 10-year Treasury Note. With that in mind, it’s always timely to take a fresh look at what financial economics tells us about projecting the equity risk premium. As a preview, there’s still precious little that’s new under the sun in strategic terms. Yet researchers keep chipping away at the nuances of asset pricing, and every now and then they turn up intriguing and perhaps useful clues for peeling away another layer of uncertainty in projecting risk premiums.

…the efficient market hypothesis is a kind of catch-22 of investing. Information that is predictable is worthless because it is already reflected in stock prices. The information that is valuable and can be used to make money is that information which cannot be predicted.

But investors require a risk premium to hold stocks, and history suggests the demand is sated. Not over every period in the short run, or in any given stock or even one stock market. The global equity risk premium, however, tends to be relatively durable, largely because global economic growth is reliably persistent over the long haul.

In fact, risk premia overall are linked the ebb and flow of economic conditions. As Professor John Cochrane explains in a chapter from the Handbook of the Equity Risk Premium:

Some assets offer higher average returns than other assets, or, equivalently, they attract lower prices. These “risk premia” should reflect aggregate, macroeconomic risks; they should reflect the tendency of assets to do badly in bad economic times.

In fact, lots of research tells us, backed up by the historical record, that the equity premium fluctuates. That’s not obvious by looking at the long-term record. Indeed, we know that the S&P 500 has generated a roughly 10% total return since 1926, according to Ibbotson Associates. (We can figure out the equity risk premium from this record by subtracting, say, the 3.7% annualized total return of 3-month T-bills over that span from the equity market gain.)

Yet looking at equity returns in smaller bites, such as 20-year periods, reflects a wider variety of annualized results, ranging from around 8% up to nearly 18%. Unsurprisingly, shorter time frames—five or 10 year rolling periods, for instance—harbor even more volatility in performance results.

Why does the equity risk premium vary? The basic answer is that investors require different risk premiums at different times depending on, well, lots of things. “When buyers demand increased compensation for risk, they pay lower prices, basically demanding that sellers compensate them for the increased risk that they see in owning stock,” writes Pimco’s market strategist Tony Crescenzi in his recent book Investing From the Top Down: A Macro Approach to Capital Markets. “By paying lower prices for stocks, buyers exact a 'premium' from the sellers of stock. Conversely,

when investors are risk-averse, they demand a smaller amount of compensation for the risks they see. This means that they become willing to pay higher prices, believing that equities carry relatively less risk than before. This happened in 1999 and 2000 when stock prices soared, with investors perceiving very little risk in owning stocks, a belief that was way off the mark.

The perennial challenge, of course, is developing some reasonable intuition about the period ahead. We can begin by considering the historical equity risk premium. This is naïve, of course, but it offers a reasonable benchmark as a starting point. But looking to the long-run past as the definitive guide to what’s in store over, say, the next 10 or even 20 years may be courting trouble.

How can we modify the historical risk premium to reflect something more realistic given the current conditions? There are no quick or fool-proof answers. In fact, we should look to a range of methodologies for some perspective. A full treatment is far beyond the scope here, but we might start by considering the Gordon growth model. Very briefly, quite a bit of academic study demonstrates that dividend yields and expected equity returns share a relationship, as our chart below shows. And if we consider current yield in context with its historical record of increase, we're beginning to scratch up some useful information.

If we take the current yield on the stock market (~1.7% at the end of Feb. 2010, according to Standard & Poor’s) and add that to the growth rate of dividends over the past 60 years—roughly 5%—we have an expected total return for U.S. stocks of 6.7%, or below the 9%-to-10% historical total return since 1926.

This is hardly the last word on looking ahead, but it’s a reasonable way to begin. But investors need to consider other factors as well. Academic research can be helpful in making forecasts. It’s no panacea, but the context is productive. But it's only the beginning. In fact, forecasting the equity risk premium is an ongoing chore, and one that requires continual reassessement, research and reflection.

With that in mind, here are some recent studies on the equity risk premium that are worth a look. Think of it as a taking a few more steps forward on the thousand-mile journey of prediction.

Out-of-Sample Equity Premium Prediction: Economic Fundamentals vs. Moving-Average Rules
by Christopher J. Neely, David E. Rapach, Jun Tu, and Guofu Zhou
Abstract:
This paper analyzes the ability of both economic variables and moving-average rules to forecast the monthly U.S. equity premium using out-of-sample tests for 1960–2008. Both approaches provide statistically and economically significant out-of-sample forecasting gains, which are concentrated in U.S. business-cycle recessions. Nevertheless, economic variables and moving-average rules capture different sources of equity premium fluctuations: moving average rules detect the decline in the average equity premium early in recessions, while economic variables more readily pick up the rise in the average equity premium later in recessions. When we simulate data with a habit-formation model characterized by time-varying return volatility and risk aversion relating to business-cycle fluctuations, we find that this model cannot fully account for the out-of-sample forecasting gains in the actual data evidenced by economic variables and moving-average rules.

Equity Risk Premiums (ERP): Determinants, Estimation and Implications—The 2010 Edition
By Aswath Damodaran
New York University - Department of Finance
Abstract:
Equity risk premiums are a central component of every risk and return model in finance and are a key input into estimating costs of equity and capital in both corporate finance and valuation. Given their importance, it is surprising how haphazard the estimation of equity risk premiums remains in practice. We begin this paper by looking at the economic determinants of equity risk premiums, including investor risk aversion, information uncertainty and perceptions of macroeconomic risk. In the standard approach to estimating equity risk premiums, historical returns are used, with the difference in annual returns on stocks versus bonds over a long time period comprising the expected risk premium. We note the limitations of this approach, even in markets like the United States, which have long periods of historical data available, and its complete failure in emerging markets, where the historical data tends to be limited and volatile. We look at two other approaches to estimating equity risk premiums – the survey approach, where investors and managers are asked to assess the risk premium and the implied approach, where a forward-looking estimate of the premium is estimated using either current equity prices or risk premiums in non-equity markets. We also look at the relationship between the equity risk premium and risk premiums in the bond market (default spreads) and in real estate (cap rates) and how that relationship can be mined to generated expected equity risk premiums. We close the paper by examining why different approaches yield different values for the equity risk premium, and how to choose the “right” number to use in analysis.

The Equity Premium in 150 Textbooks
By Pablo Fernández
Abstract:
I review 150 textbooks on corporate finance and valuation published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Arzac… and find that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009. Some confusion arises from not distinguishing among the four concepts that the phrase equity premium designates: the Historical, the Expected, the Required and the Implied equity premium. 129 of the books identify Expected and Required equity premium and 82 identify Expected and Historical equity premium. Finance textbooks should clarify the equity premium by incorporating distinguishing definitions of the four different concepts and conveying a clearer message about their sensible magnitudes.

Does this mean that dissent on the FOMC has been reduced to debating rhetoric vs. rates? Maybe. In any case, it’s a moot point. Rates continue to hover just above zilch in the U.S. and look set to stay there for, well, an extended period.
Is that warranted? Hoenig seems to have his doubts. So does Joseph Carson, chief economist at AllianceBernstein, who says the Fed’s internal forecast anticipates 4% GDP growth this year and in 2011. “That growth expectation eventually has to follow through to their rate policy," Carson tells CNNMoney.com. "Hoenig's arguments are well founded; staying at a 0% funds rate while the economy is starting to grow will eventually lead to imbalances."

Perhaps, although it’s not top-line GDP growth that’s the problem so much as it is the ongoing weakness in the labor market. That doesn’t give the central bank a pass, of course. Unusually low rates left to roll on for an “extended period” may cause trouble down the road, even if job creation remains weak. In fact, we’d be surprised to find that the cheap money doesn’t come back to haunt the economy at some point. That doesn’t make raising rates any easier given the labor market; nor does it ease the anxiety about keeping the price of money at near zero. But it does remind that there are no easy decisions at the moment in the golden age of easy money.

But some intriguing clues are bubbling, according to Bloomberg News:

Money market interest rates at five-month highs show the Federal Reserve is laying the groundwork to siphon a record $1 trillion in excess cash from the banking system and sending a bearish signal on Treasuries.

Overnight federal funds rates rose to the highest since September and the cost to dealers to borrow and lend U.S. securities for one day more than doubled in the past month. Three-month Treasury bill rates rose last week to the highest since August.

The rise is a sign traders are preparing for tighter monetary policy as stimulus measures end. In the three months before the Fed started raising borrowing costs in June 2004, 10- year Treasury yields rose about 0.75 percentage point as bond prices fell. While higher rates mean increased borrowing costs for President Barack Obama, they also show growing confidence that the economic recovery is gaining traction.

“The Fed is definitely getting its ducks in a row,” said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services Ltd., which oversees $7.5 billion. “There is no doubt that in the early phases of the Fed’s plan, the Treasury market could suffer.”

But for the moment the ducks are likely to stand pat. The only change will be the rhetoric in the FOMC statement, opines Greg Robb of MarketWatch.com. The "extended period" phrase in policy pronouncements of late that implied low rates as far as they eye could see, including this FOMC statement issued on January 27, may be retired, he writes. "Altering the wording would be a clear signal that the Fed is more sanguine about the economic outlook and believes ultra-low rates are no longer necessary -- and financial markets would react accordingly," Robb forecasts.

In any case, we need to bit off this beast in small chunks. Let's take it slow, starting with this short Q&A from the Washington Post on the "6 key points of the financial regulation legislation."

The Chinese have been asserting for some time that revaluing the currency was a non-starter. Earlier this month, China's central bank chief said as much, as we discussed here. Wen's comments yesterday only strengthen his country's resolve.

Paul Krugman didn't use the P word in his New York Times column today in "Taking On China" over its "policy of keeping its currency, the renminbi, undervalued." He didn't need to. It was hard to ignore the protectionist implications in Krugman's recommendation of imposing a temporary surcharge of 25% on Chinese imports coming into the U.S. "I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand."

Perhaps, but protectionism, whether you call it that or not, comes with a fair amount of economic risk. Nonetheless, "Despite the economic arguments against it, protectionism has an undeniable political allure," write William Baumol and Alan Blinder in their textbook Macroeconomics: Principles and Policy. "It seems, superficially, to 'save American jobs,' and it conveniently shifts the blame for our trade problems onto foreigners."

For good or ill, noises from both Republicans and Democrats these days seem to favor some form of retaliation for China's artificially weak currency. According to BusinessWeek:

U.S. lawmakers, including Senator Charles Schumer, are proposing that China be hit with stiffer tariffs to compensate for the unfair export advantage they say comes from an undervalued currency. Economist Paul Krugman estimates that global growth would be about 1.5 percentage points higher if China stopped restraining the value of the yuan, and after Wen’s comments said the U.S. should consider putting a 25 percent surcharge on Chinese goods.

“Chinese officials are alone in their refusal to acknowledge that the yuan is undervalued,” Senator Charles Grassley, an Iowa Republican, said in a statement responding to Wen’s remarks. “If they choose to stick their heads in the sand, we’ll have to find another way to address this problem because it’s been going on for far too long.”

Expect more of this tough talk on trade policy in the U.S. as mid-term elections in November draw near at a time when the U.S. continues to suffer from a weak labor market and a risk of sluggish economic growth. "There's nothing off limits when election-time comes around, and China makes themselves an easy target," Ralph Cossa, president of the Pacific Forum at the Center for Strategic and International Studies, told AP.

But launching a trade war runs the risk of a conflict spinning out of control. Nations can retaliate, which can spur more action on the other side. Given the high degree of political anxiety in the world these days over economic affairs, the hazards of protectionism seem higher than usual. History certainly offers little support for thinking that a nation can launch a trade war and contain the blowback while reaping the lion's share of the game. It's also a myth that trade wars can be fought on a limited scale, by targeting a particular ill or country. Surgical strikes simply don't exist with protectionism, even on a small scale, in a globalized economy.

"Although a trade war may not be as destructive as a military warn," writes Randy Epping in The 21st Century Economy, "in both cases many suffer--often the very people the war was meant to protect."

In any case, it's misleading to think that a stronger yuan is the cure-all for what ails the U.S. A tempting idea, but one with limited mileage. China's export machine draws on more than a weak currency. Much more, as James Fallows explains in Postcards from Tomorrow Square: Reports from China.

Nonetheless, don't underestimate the potential fallout from a trade war, or its apparent solutions. Yes, the Chinese currency is a problem for the global economy. Launching a new round of protectionism almost certainly isn't the answer. The real challenge is coming up with policy responses that a) have a reasonable chance of success; and b) don't end up causing more damage than the original problem. There are no easy answers, of course, which is what makes protectionism's simplicity so appealing...and dangerous these days.

Assuming deductions, exemptions and credits were kept the same as they are now, Congress would have to raise each personal income tax rate by a factor of almost two and a half to erase the 2010 deficit. Even in later years when the President's Budget predicts that the deficit will be "only" in the $700-to-$800 billion range, the rates necessary to close the deficit are untenable.

The CBO projects a budget deficit for fiscal 2010 of $1.3 trillion. According to the Tax Foundation, blotting out that red ink by way of higher personal income taxes—all in one year—would require more than doubling the current tax rates. For the upper income levels, a near tripling of the tax burden would be required, as the table below shows.

The chances of Congress raising tax rates to close the deficit in one year, much less having the President sign off on the idea, is about as likely as waking up on Saturn tomorrow morning. The Beltway boys and girls don’t usually favor politically self-destructive legislation. If anything, they’re partial to the opposite spectrum of legislative activity, which is part of what got us into this deficit trouble in the first place.

Yes, higher tax rates are coming, and may already be bubbling before they're formally announced, as we discussed last week. But higher rates are likely to come quietly in the night, as opposed to dropping out of the blue on Monday morning with a formal press conference announcing the change on the front steps of the Capitol. No doubt there'll be other changes, too, including cutting back on certain spending projects that lack a large and influential constituency, i.e., something other than Medicare, Social Security, etc.

In any case, the Tax Foundation’s quantitative “what if” review is a reminder of just how deep a hole that’s been dug and what it would take to climb out. Assuming we even try. History suggests that printing money is the political path of least resistance. And for good reason: it works, at least until the next election. And even then, there are limits, which is to say that it works until it doesn’t.

For the moment, the bond market has a high level of tolerance for fiscal impropriety. That’s largely a function of the political cover that flows from the deflation/disinflation blowback generated by the Great Recession. But tomorrow, as Scarlett once said, is another day. So too is what passes for tolerance.

Much depends on how we crunch the numbers. If we look at the trend in actual retail dollars spent on a monthly basis (seasonally adjusted), the trend looks clear. As our first chart below shows, Joe Sixpack is spending considerably more than he was a year ago.

But if we’re looking for big-picture trends as it relates to the economic cycle, we need to look at more than just month-by-month dollar comparisons. Monthly percentage change is one option, although there’s quite a bit of statistical noise here. Looking at rolling 12-month percentage change helps filter out some of the noise and focus on the broad trend, many economists advise. This is no silver bullet, nor is any other lone piece of data. But as economist Joseph Ellis outlines in Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles, it’s all about finding context. Looking at key economic variables with some perspective helps. With that in mind, consider our second chart below, which graphs retail sales on a year-over-year basis.

Clearly, retail sales have recovered on a percentage basis from the Great Recession. That’s not surprising, given the enormous monetary and fiscal stimulus over the past year. The challenge will be one of keeping the rebound intact. On that note, the modest slippage in the 12-month pace of change in recent months may be simply random behavior. But given the economic context of late, perhaps there’s something more ominous lurking in the trend. We simply don’t know. It all depends on how consumers act in the months ahead, and to some extent that will depend on the labor market.

"While we are not expecting the consumer to come roaring back in the near-term, improvements have been quicker than expected considering the still-distressed state of the labor market," according to Adam York, an economist for Wells Fargo Securities, via MarketWatch.com.

It’s still all about jobs, jobs, jobs, even if today’s it’s about conspicuous consumption.

Ms. Yellen, president of the Federal Reserve Bank of San Francisco since 2004, has been a strong supporter of Fed Chairman Ben Bernanke's policies to fight the deep economic downturn.

Ms. Yellen, 63 years old, was chair of the Council of Economic Advisers from 1997 to 1999 under President Clinton, after serving as a member of the Fed's Washington-based Board of Governors for three years.

One of the more dovish policy makers among the Fed's 12 regional bank presidents, Ms. Yellen has been a key advocate of the Fed's policy of near-zero interest rates and a massive expansion of the central bank's balance sheet, even as some regional Fed officials advocate for pulling back the monetary stimulus more quickly.

Reacting to the news, Yoshio Takahashi, a fixed-income strategist at Barclays Capital in Tokyo, tells Reuters: "Given the fact Yellen is seen as most dovish among FOMC members, the market is likely to think that the Fed may take more time until it decides to raise interest rates."

Meantime, it looks like Paul Krugman will continue writing for the NY Times after all.

Vasia Veremi may be only 28, but as a hairdresser in Athens, she is keenly aware that, under a current law that treats her job as hazardous to her health, she has the right to retire with a full pension at age 50.

“People should be able to retire at a decent age,” Ms. Veremi added. “We are not made to live 150 years.”

Perhaps not, but it is still difficult to explain to outsiders why the Greek government has identified at least 580 job categories deemed to be hazardous enough to merit retiring early — at age 50 for women and 55 for men.

Greece’s patchwork system of early retirement has contributed to the out-of-control state spending that has led to Europe’s sovereign debt crisis. Its pension promises will grow sharply in coming years, and investors can see the country has not set aside enough to cover those costs, making it harder for Greece to borrow at a reasonable rate.

As a consequence of decades of bargains struck between strong unions and weak governments, Greece has promised early retirement to about 700,000 employees, or 14 percent of its work force, giving it an average retirement age of 61, one of the lowest in Europe.

The law includes some dangerous jobs like coal mining and bomb disposal. But it also covers radio and television presenters, who are thought to be at risk from the bacteria on their microphones, and musicians playing wind instruments, who must contend with gastric reflux as they puff and blow.

And Greece may be an early indicator of troubles to come. Bigger countries like Germany, France, Spain and Italy have relied for decades on a munificent state financed by a range of stiff taxes to keep the political peace. Now, governments are being pressed to re-examine their commitments to generous pensions over extended retirements because the downturn has suddenly pushed at least part of these hidden costs to the surface.

This is no trivial matter, considering the value of initial jobless claims as one of several leading indicators for the economic cycle. (For some background, see our previous posts here and here. In addition, you can find some examples of the formal research on the subject here.) The best we can say at this point is that the jury’s still out on the big picture trend. Jobless claims are a volatile series on a weekly basis, and even over longer stretches, as the chart above reminds. But the time is running short when we can look at a sideways-moving trend in claims and dismiss it as statistical noise. All the more so at a time when the labor market's capacity for creating new jobs remains, at best, questionable, as the latest update in nonfarm payrolls shows.

Meanwhile, we take no encouragement from the trend in continuing claims, which tracks the population of folks who’ve been collecting jobless benefits for more than a week. This number is reported with a lag relative to initial claims, but the latest figure reported today supports the case for thinking that we may be moving sideways for some period of time in the job market overall. For the week through February 27, continuing claims rose by 37,000 to 4.558 million (seasonally adjusted). And as our second chart below shows, this series has been going nowhere fast so far this year.

But all’s not lost yet, advises James O’Sullivan, global chief economist at MF Global in New York. "The net rise in the last two months was because of temporary factors, notably weather effects," he tells BusinessWeek today. "Claims will likely have to resume a downward trend if payrolls are to improve, which we think will happen."

Hope springs eternal, or at least until next week's report.

It’s too soon to draw final conclusions, but so far at least there’s reason to wonder if a broader array of risk and return profiles are coming in stock markets across the globe. Such a future isn’t hard to rationalize if consider what appears to be shaping up as relatively divergent economic and financial futures depending on the corner of the world under discussion.

As the IMF recently reported in its latest economic outlook for the global economy, “growth performance is expected to vary considerably across countries and regions, reflecting different initial conditions, external shocks, and policy responses.” The report goes on to explain,

For instance, key emerging economies in Asia are leading the global recovery. A few advanced European economies and a number of economies in central and eastern Europe and the Commonwealth of Independent States are lagging behind. The rebound of commodity prices is helping support growth in commodity producers in all regions. Many developing countries in sub-Saharan Africa that experienced only a mild slowdown in 2009 are well placed to recover in 2010. Growth paths are diverse for advanced economies as well.

Is this something different from the usual variation? Indeed, there’s always a rainbow of results. It’s a big world, after all, and everything from central bank policy to tax rates to managing and regulating the marketplace differs. But those factors, and more, are arguably in overdrive these days and will remain so in the years ahead. One reason is that the policy responses to the global recession will vary to a wider degree over time. That’s not obvious based on the recent past, when the common theme has been a relatively coordinated policy response of rapidly lowering interest rates over a short period.

But while everyone was doing something similar in 2008 and 2009, it’s not unreasonable to wonder if a more varied mix of exit policies awaits. Economic conditions are likely to evolve in dramatically different ways for the foreseeable future. Divergence is already beginning to emerge. In Australia, for instance, the central bank has been raising interest rates since mid-2009 as the economy recovers at a relatively rapid pace compared with other industrialized nations. By comparison, U.S. monetary policy is expected to remain unchanged deep into 2010.

Meanwhile, there’s a substantial degree of difference in the debt structure around the world. Almost every country borrowed money to fund the liquidity injections, but the blowback from the red ink hasn’t been far from uniform. Britain, for instance, has will have an estimated fiscal deficit that’s more than twice as large (measured in relative terms against GDP) compared to Germany this year, according to a recently study published by Bank for International Settlements. Meanwhile, China’s fiscal red ink is expected to be just one-fifth of India’s for 2010.

One implication from all this is that if the global equity market delivers modest results in the years ahead, as some strategists predict, that relatively calm and mediocre exterior may hide a comparatively wider array of returns and risks bubbling on a regional and national basis. In turn, that means that there are greater opportunities for dynamically managing asset allocation. It also means that volatility and hazards are higher.

A more diverse world of equity results may be coming, but there’s still no free lunch on the menu.

The rise in long-term unemployment may have ramifications for the economy going forward. The likelihood of finding a job tends to decline as an individual remains out of work for a longer period. Partly this reflects the fact that those who typically have a difficult time finding work will tend to be unemployed longer. In this case, longer spells are a symptom rather than the source of an underlying problem. However, a long unemployment spell could itself cause deterioration in a worker’s skills, leaving some of the long-term unemployed with less bright job prospects even as the economy begins to revive. This could contribute to high average unemployment duration for some time.

One of the smoking guns for thinking this is the future that awaits comes by way of the duration of unemployment. "In February," Evans explains, "over 40% of the unemployed were in the midst of a spell lasting more than six months, by far the highest proportion in the post-World War II era."

The trend of rising duration this time around was graphically shown in a chart Evans used in his talk, which is reproduced below. The graph plots the jobless rate (horizontal bar) vs. the average length, or duration, of unemployment since 1947. The basic trend is that duration rises as the unemployment rate increases. When the Great Recession began, the jobless rate was roughly 5% and duration was around 17 weeks. In other words, we began the current contraction in a weakened state that was substantially worse than usual. And it's deteriorated ever since.

Indeed, the red dots in the chart above show the monthly statistics for 2008 and 2009. The bottom line: the jobless rate and the average length of unemployment are at the highest in more than 60 years. This is disturbing for obvious reasons, along with some not-so obvious ones. As Evans said, "The likelihood of finding a job tends to decline as an individual remains out of work for a longer period." The not-so-astonishing implication:

…long-term unemployment tends to lead to permanent earnings losses, particularly for those who have previously invested heavily in job- or industry-specific skills. So, high unemployment durations could have long-lasting effects on consumer confidence and demand.

In other words, there's a heightened risk "that the recovery in labor markets could be slow even as output returns to a well-established growth path," he said.

You didn't necessarily hear it here first, but rarely has the warning been so loud and clear from the central bank's upper ranks.

…once the [yield] curve is inverted, the odds greatly increase that a recession is unavoidable. Just how certain can we be a recession will occur? Let history be a guide. Since 1960, all six U.S. recession have been preceded by an inverted yield curve months in advance. No other indicator has shown such consistency, not even the stock market.

Many other variables have shown varying degrees of usefulness in predicting returns. Indeed, a deep and broad array of published empirical literature since the 1980s in particular demonstrates that a range of predictors offer robust forecasting ability. There is an ongoing debate over the source of the predictability and the extent that the predictability translates into real-world profit opportunities. In the short term, for instance, there are few robust predictors. Meantime, there's also an ongoing discussion about whether the predictability is evidence of a rational world where expected returns vary vs. seeing the predictability as evidence of irrational behavior. There is wide recognition, however, that expected returns vary with some degree of predictability. That's no silver bullet, but it opens the door for thinking that we can enhance the equilibrium returns dispensed by the market portfolio.

A small sampling of the literature that supports the case for return predictability includes:

* Research on stock market dividend yield and other accounting-based metrics for equities
* Return-based volatility trends
* Correlation trends among asset classes
* Short-term return persistence (momentum)
* Relative return among asset classes

And, as we noted, the term structure of interest rates (i.e., the yield curve) is among the many predictors that have been productively analyzed through the years.

Critics argue that individual variables that perform well in historical tests often fail to deliver comparable results in out-of-sample tests, i.e., in periods outside the testing dates. For example, a recent academic study reports that individual predictors don’t outperform simple forecasts drawn from historical averages (“A Comprehensive Look at the Empirical Performance of Equity Premium Prediction,” by Amit Goyal and Ivo Welch, Review of Financial Studies, 2008).

On the surface, this looks fata for thinking that forecasting factors are useful in the real world. But the evidence that any one predictor fails at times is unsurprising. Even if a flawless predictor was able to deliver a constant stream of accurate return forecasts (a virtual impossibility, of course), its value would soon be arbitraged away. News of this predictor’s incessant forecasting strength in the past would quickly attract new investors, who would then embrace the predictor, thereby rendering its practical value nil by bidding up the relevant assets to prices that reduce expected return to zero or less. In addition, fluctuating economic conditions are likely to provide varying degrees of predictability power to any one predictor at different points in the business cycle.

The challenge for investors is interpreting the literature on predictors and deciding how to utilize the research while recognizing that the forecasts will be less than perfect at all times. A possible solution is combining predictors to minimize the potential for failure in any one predictor at times. In other words, by diversifying the set of predictors used to forecast returns, the reliability of the prediction may be enhanced, if only marginally.

The economic rationale for combining individual predictions as a means of raising the success rate of forecasts dates to research published more than 40 years ago ("The Combination of Forecasts," by J.M. Bates and C.W.J. Granger, Operational Research Quarterly, 1969). This paper is widely cited as establishing the basis for showing that multiple forecasts are superior to individual forecasts.

Subsequent research over the years has strengthened the case for expecting pooled forecasts to outperform its components in isolation. A 1983 paper, for instance, observes that combined forecasts "can be quite accurate" ("The Combination of Forecasts," by Robert Winkler and Spyros Makridakis, Journal of the Royal Statistical Society, 1983). And a 2004 study shows that combining forecasts of economic growth has a habit of outperforming individual predictions (“Combination Forecasts of Output Growth in a Seven-Country Data Set,” by James Stock and Mark Watson, Journal of Forecasting, 2004).

Applying the concept of combination forecasts to predicting the equity risk premium, a paper published this year demonstrates so-called out-of-sample predictive power for 15 economic variables when used in concert for predicting the excess return for stocks. Diversifying the set of predictors, in other words, minimizes forecast errors, according to "Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy," by David Rapach, et al. (Review of Financial Studies, 2010).

Using multiple predictors to forecast risk premiums is a relatively recent line of research for financial economics, even though the underlying concept has been formally recognized for decades. Is this a short cut to big gains? Of course not. But as researchers continue to peel away the onion skin, the mysteries of asset pricing continue to be revealed, albeit slowly and unevenly.

The lessons from the evolving research with combination forecasts are intriguing. One of the implications is that forecasting risk premia requires a broad set of predictors. In effect, investors should diversify the sources of their forecasts. This reasoning is that each predictor's value rises and falls through a business cycle. Different predictors harbor different information about what's coming at different times. As such, drawing predictions from predictors whose information is highly correlated is subject to a higher failure rate compared to a more diverse and carefully chosen mix of predictors.

This may be a revelation to some, but it's actually more of the same in financial research. “The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk,” Peter Bernstein explained in Against the Gods: The Remarkable Story of Risk. This revolution is in fact a continuum of ideas and insights. That includes the growing evidence that we can't blindly assume that one, or even a handful of randomly chosen predictors will suffice. Investing is hard work, and it's destined to get harder. So it goes for investors as they continue to eat under the tree of financial knowledge.