The battleground in the stock market these days is the question of whether or not the economy will rebound this year. However, after looking at some compelling data over the past week, we think there is a decent chance that the economy may be in the process of rebounding right now.
Okay, before the booing, the name calling, and the accusations of our views falling into the perma-bull/optimist camp starts, please open up your mind and allow me to explain.
For starters, please understand that there is a distinction between the economy being on the mend and the recession actually ending. To be clear, we are not suggesting that the recession has ended at this point. Instead we are of the mind that the end is in sight and it may be closer than most economists believe.
Let’s also remember that the official pronouncements of recessions beginning and ending comes from the National Bureau of Economic Research, which uses a VERY healthy dose of hindsight to make their calls. So, since the stock market is a forward looking vehicle and the NBER calls are backward-looking, waiting for the official word that the recession has ended isn’t very helpful to investors.
The general consensus is that the recession will end sometime in the second half of 2009 and the economy will begin to grow again in the first half of 2010. And the good news is that, according to my calendar, we are getting pretty close to the all-important second half of 2009.
However, in looking at a bunch of economic reports designed to be leading indicators of the economy, we find that the end of the recession could come in the early part of that “second half of 2009” window.
Searching for Signs of Recovery
With a little help (well, okay – a lot of help) from the good folks at Ned Davis Research, we’d like to review five different indicators that have solid track records in terms of calling the end of a recession ahead of time: The US stock market and data on employment, consumer sentiment, housing, and manufacturing.
The Stock Market
The old joke is that the stock market has “called” nine of the last six recessions. The implication is that the market gets a little jumpy at times and will, on occasion, see things that aren’t there. However, it is interesting to note that if one looks at the general consensus of economists, history shows this group has actually called zero of the last six recessions ahead of time. And perhaps this is the reason that the average investor is so good at preparing for what has already happened!
The concept of using the stock market to project the direction of the economy actually makes some sense. Most everyone knows that stocks look ahead between three to nine months, depending on who you talk to. Thus, if the stock market has been falling and then turns higher, it is logical to assume that the market is then projecting better times ahead.
To put this into an indicator format, NDR uses an eight-month moving average of the S&P 500 as the signal for the economy. When the S&P has been below its 8-mo moving average and then moves above it, an expansion signal is given and vice versa.
Going back to 1948, there have been 15 prior signals where the stock market has “called” an expansion in the economy and 9 of the signals occurred while the economy was actually in a recession as defined by NBER. During the 9 recessions, the market effectively got it right in terms of calling for an end to the recession 8 times out of 9.
The signals were not always perfect, but the important thing to note is that the median lead time for the bottom in the stock market calling a recovery in the economy has been about four months. So, the market appears to be calling for an end to the recession in July.
Employment
Nonfarm payrolls is one of the most important indicators used by the National Bureau of Economic Research in defining the business cycle in the U.S. And as anyone watching the market knows, it is the monthly jobs report that is the “big Kahuna” of economic data.
In looking back at recessions since 1948, NDR found that employment is more of a coincidental (to slightly lagging) indicator of the economy and that the maximum monthly job losses typically occurs two months before the economy turns upward. So, if monthly job losses peaked in January, this would suggest that the economy should be turning right now.
Consumer Sentiment
In light of the fact that the consumer accounts for two-thirds of this country’s gross domestic product (GDP), it is easy to see that when consumers are happy the economy is usually in pretty good shape.
What we look for in making a call for the economy is a trough in consumer sentiment. Using the Reuters/University of Michigan Consumer Sentiment Index (which goes back to 1952) we find that a trough in this index has led economic expansions by a median of two months. And since the index bottomed in November – you get the idea.
Home Sales
Although we’re sure to start an argument with this topic, sales of new homes is a very good indication of how the economy is doing. And since it is safe to say that housing has played a major role in this particular downturn, we need to be mindful of an upturn in the housing market.
While no one is going to suggest that the housing market is improving to any great degree at the moment, the data shows that things have stopped getting worse. And history suggests that a trough in new home sales has occurred a median 2.5 months before the beginning of the next expansion cycle in the economy. However, it is important to note that this data tends to be volatile and the range of lead times is between two and nine months.
The good news is that so far at least, sales of new homes appears to have bottomed in January – so, we’ll be watching this one closely for signs of improvement.
Manufacturing
Since this might qualify as hard core economic data that has been proved to induce drowsiness, we’ll cut to the chase. The ISM Manufacturing Composite Index measures manufacturing activity and has bottomed a median 2.5 months before the end of recessions. And unless manufacturing collapses from here, we can say that this index bottomed in December. Thus, this indicator also projects a turn in the economy starting any time now.
Here’s the Rub
The five indicators we chose to highlight this weekend are not the only ones singing a happy tune at the present time. Thus, the data suggests that the economy may turn around sooner than most economists and investors think; which, of course, is a good thing for the stock market.
So, what could change this rosy scenario? In short, a new low in the indicators would definitely be
