Recent economic data for the US suggests that the stock market’s hissy fit this year has been a false signal for anticipating a new recession. That’s not surprising—the short-term noise in equity prices is a constant challenge for business-cycle analysis and so it’s not uncommon that market volatility will lead us astray at times. That’s always been the case and nothing’s changed. Looking to markets in isolation of hard economic numbers is a dangerous game if real money is at stake. The challenge is finding a happy medium. The good news is that there are several choices for relatively reliable signals.
If you could only look at one measure of economic activity for monitoring recession risk the single-best indicator is the Chicago Fed’s National Index—the three-month moving average (CFNAI-MA3) in particular. In the grand scheme of macro benchmarks that are publicly available for free from institutional sources, CFNAI-MA3 is a tough act to beat.
Like all efforts at monitoring recession risk, CFNAI-MA3 is forced to make compromises. But in a world of generally poor choices, this index provides what is arguably the best mix for finding the sweet spot between reliability and timely signals. The reliability aspect is a direct function of its broad design that incorporates 85 indicators. The monthly frequency suffers from a bit of a lag, but this updating schedule is useful because it helps us look past the day-to-day numbers that can offer confusing messages.
It’s no trivial point that CFNAI-MA3’s track record is encouraging in terms of dispensing comparatively timely and accurate signals about recession risk. For example, a review of the index’s vintage data shows that CFNAI-MA3 issued a recession warning on Mar. 24, 2008. That was a timely call when you consider that the economy peaked only a few months earlier, in Dec. 2007, according to NBER’s data.
Keep in mind that that many analysts—including a number of high-profile economists—continued to argue into the spring and early summer of 2008 that the US would avoid a recession.
But the past is always clear. Developing reliable recession-risk signals in real time is another matter entirely. At least we know where to begin. There’s no guarantee that CFNAI-MA3 will issue another reliable early warning in the future, but given what we know about this benchmark it would be surprising if it stumbles. The question is whether we can develop a bit of advance insight into CFNAI-MA3’s monthly updates?
A cautious “yes” is in order. One effort on this front arrives on these pages a few days ahead of each monthly CFNAI-MA3 release via The Capital Spectator’s Economic Trend & Momentum indexes–here’s last month’s edition. As I detailed in
Nowcasting The Business Cycle (Chapter 12), the vintage data for those two benchmarks offered an advance warning of trouble relative to CFNAI-MA3’s Mar. 24, 2008 recession call.
We may be able to do even better, if only slightly, in the cause of developing relatively early, reliable signals, which is the mandate of the intra-month updates of The US Business Cycle Risk Report.
And, yes, we should continue to look at the stock market and other market-based indicators—but in concert with formal economic numbers. The danger is assuming that any one source will tell us all that we need to know for monitoring recession risk. That’s never been true and it never will be. Every recession is unique in some degree. There are often common factors in the mix—monetary tightening, for instance. But the future’s uncertain and so the possibility of economic contraction for reasons that aren’t obvious in real time is always lurking.
This much is clear: the next recession will be accompanied by a stumbling stock market. The caveat is that a stumbling stock market doesn’t necessarily mean that a new recession has started. How will we know the difference? By routinely monitoring a broad set of numbers. Yes, that’s hard work and it doesn’t offer much opportunity for snappy headlines and two-minute TV interviews.
The good news is that early and relatively reliable signals for estimating recession risk aren’t beyond our grasp. In fact, spending 60 seconds a month with the CFNAI-MA3 updates is arguably the most-efficient and reliable way to keep an eye on US business-cycle dangers. It’s useful to know that this data has been telling us that Mr. Market’s recent warnings looked suspect.
On that note, the current CFNAI-MA3 data advises that recession risk was low as of January. Granted, we had to a wait a month to see that data, but so far the benchmark has been more signal than noise.
The early clues for February suggest a repeat performance when the next CFNAI-MA3 arrives on Mar. 21. Is that written in stone? No, of course not. For what it’s worth, Mr. Market’s still dispensing forecasts of trouble. But until we see confirming data in CFNAI-MA3 and similar benchmarks, the case is still weak for downgrading the current view of cautious optimism on the US macro outlook.