Read all of Dr. Hussman's weekly market commentaries
here.
Accompanying the news of the "grand and
comprehensive" European solution on Thursday was the news that GDP rose
at an annual rate of 2.5% in the third quarter. There was already
coincident data that the U.S. was not yet in contraction in August or
September, so this was no surprise. Still, investors continued the habit
of confusing lagging and coincident indicators for leading ones, so the
positive GDP figure was taken as evidence that an oncoming economic
downturn was "off the table."
I can't emphasize enough that leading evidence is in fact leading
evidence. Take, for example, the ECRI Weekly Leading Index. It's
certainly not a perfect indicator in itself, but its leading properties
are instructive. If you look at the historical points where the WLI
growth rate fell below zero, you'll find that weekly unemployment claims
(a coincident indicator) were generally still about 3% below their
5-year average. It generally took about 13-16 weeks for unemployment
claims to climb above that 5-year average, and even longer for the
unemployment rate (a lagging indicator) to rise sharply. That's not much
of a lag in the grand scheme of the full economic cycle, but allows a
great deal of intervening and often contradictory action in the
financial markets.
The tendency to demand predictable outcomes to
also be immediate is a dangerous one, because it allows investors to be
sucked in by temporary reprieves during what are, in fact, very negative
conditions. As I noted in May (see
Extreme Conditions and Typical Outcomes ),
"It's clear that overvalued, overbought, overbullish, rising-yields
syndromes as extreme as we observe today are even more important for
their extended implications than they are for market prospects over say,
3-6 months. Though there is a tendency toward abrupt market plunges,
the initial market losses in 1972 and 2007 were recovered over a period
of several months before second signal emerged, followed by a major
market decline. Despite the variability in short-term outcomes, and even
the tendency for the market to advance by several percent after the
syndrome emerges, the overall implications are clearly negative on the
basis of average return/risk outcomes."
The same can be said here of economic prospects.
Investors have almost entirely abandoned any concern about recession
risk based on a few weeks of benign economic figures. Yet on the basis
of indicators that have strong leading characteristics, a
broad ensemble of evidence continues to suggest very high recession
risks, and even sparse combinations of indicators provide a major basis
for concern.
For example, since 1963, when the ECRI Weekly
Leading Index growth rate has been below -5 and the ISM Purchasing
Managers Index has been below 54, the economy has already been in
recession 81% of the time, and the probability of recession within the
next 13 weeks was 86%.
If in addition, the S&P 500 was below its
level of 6 months earlier, the economy was already in recession 87% of
the time, and the probability of recession within the next 13 weeks
climbed to 93% (and then to 96% within 26 weeks). Under these
conditions, once the PMI fell below 52, the probability of recession
within 13 weeks climbed to 97%.
