Leading, Coincident indicators support forecast of weakness now, strength in the second half

- by New Deal democrat

With the release of real retail sales Monday and industrial production yesterday, we now know the numbers for 3 of the 4 big coincident indicators for the economy. Payrolls were reported two weeks ago and personal income hasn't been reported yet. With housing permits being reported yesterday, we also know what the most important long leading indicators are forecasting through early next year.

Let's start with the long leading indicators. These include real M2 (green) and corporate bond interest rates (inverted)(red) as well as housing permits (blue) :



Long leading indictors forecast the economy 12+ months later. Many people also include the yield curve in this group. The problem with the yield curve is that it does not function well in times where deflation is a real possibility (it never inverted between 1930 and 1950, for example). In any event, 12+ months ago was just as these indicators were approaching a nadir. Hence my belief that the weakness shown in several series in the last few weeks is real.

But note that beginning in spring 2011 all three turned up. This tells me the weakness will be short lived and we should expect relatively strong growth as we go into the second half of this year.

Next let's look at shorter leading indicators, which forecast the economy 6 to 8 months later. The raw ECRI WLI is a good index of these. In the graph below it is shown in orange (h/t Kirk Lindstrom):



The big downdraft in the WLI occurred last September, 7 months ago. This confirms the forecast for weakness in the next few months.

Finally, here are the 4 big coincident indicators -- real retail sales (blue), payrolls (red), industrial production (green), and real personal income ex transfer payments (orange):



Through March, two are rising and one is flat. We don't know about real personal income yet, although it has declined slightly in the last couple of months. Two of the three that we do know are weaker than they were a few months ago, but notice that the trends were much worse last spring.

Digging a little deeper, let's look at one of my favorite comparisons, real retails sales vs. payrolls:



As this graph plainly shows, consumption leads jobs. With real retail sales strongly positive through March, it is likely that payrolls will continue positive through the second quarter.

Next, here's the same relationship on a YoY% basis (with retail sales divided by 2):



Real retail sales do a decent job of forecasting amplitude as well as direction, although obviously not perfect. With real retail sales continuing to run at about 5% YoY, it is likely that payrolls will not deviate much from their current 1.5% YoY rate.

The bottom line is that, barring extreme revisions, the first quarter of 2012 showed continued growth, and it is likely that jobs growth persists in second quarter as well.

Per my recent commentary, I do think there will be a slowdown in that growth for the next several months, but I do not see anything strong enough to take us into actual contraction at this time. To the contrary, the upturn of the long leading indicators last spring and the short leading indicators since the beginning of this year buttress the argument that we should see relatively better growth in the second half of this year.

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Can you really have a recession if houses and cars (and stocks and bonds and money supply and a bunch of other stuff ) won't play?

- by New Deal democrat

A recession in economic terms isn't synonymous with a period of hard times. Rather, it is a contraction in the economy. Can one really happen if leading sectors don't decline, and with no warning from the usual indicators?

Take housing. Here is a graph of housing permits, an acknowledged long leading indicator, for the last half a century:



Not once during that time has housing failed to turn down in advance of a recession. The weakest decline was from 1.742 million units annualized in December 1998 to 1.542 million annualized in July 2000, a decline of 200,000. The closest comparison in our situation is the decline of 154,000 from June 2010's 688,000 annualized permits to February 2011's 534,000. Since then permits have risen back to 682,000 in January of this year.

There is simply no post-WW2 for a recession happening without housing construction declining first. The only possible precedent is the slight increase in houses built in 1938 vs. 1937, but the statistics are only annual so we have no way of knowing what kind of quarterly or monthly declines may have occurred.

Records of vehicles sold have not been published on that long a basis, but the records we do have suggest that vehicle sales too have almost always declined in advance of a recession:



The only exception here is the Volcker induced recession due to the Fed hiking interest rates to 20% to break an inflationary cycle.

Another statistic getting a lot of attention recently is initial jobless claims. These have continued to fall to new lows:



Never since these statistics began to be kept almost 50 years ago has a recession occurred without initial claims turning up first. The minimum period of time from the bottom to the onset of recession was 2 1/2 months.

Another long leading indicator is bond prices. Since WW2 there has never been a recession without bond prices declining (i.e., bond yields increasing). Here is a graph showing inverted yields of BAA corporate bonds (i.e., prices):



While the above are weekly, monthly BAA bond prices go all the way back to 1919. Here is the graph of monthly prices from then until the 1960's"



Only twice did BAA bond prices not decrease before the onset of recession: in 1927 and in the 1945 demobilization.

Real money supply is also generally thought to be a long leading indicator. Again, since modern records have been published, at no time has a recession occurred without Real M1 turning negative first:



During the deflationary 1920's and Great Depression era, negative real money supply was at very least coincident with the onset of recession.

Stock prices are also at least a short leading indicator. While famously stocks continued to rise for three months after the economic downturn began in 1929, in our era their record continues to be good if not perfect:



Stocks only failed to turn down in advance of the 1980 and 1990 geopolitical Oil shocks.

Average hours worked in manufacturing has long been considered a leading indicator as well, and these records are available since WW2.



Again, there has only been one exception, in this case 2007 right before the "Great Recession."

I have found only two leading indicators that might support the case for an imminent contraction. Nondefense durable goods orders ex-transportation show clear signs of rolling over:



Further, if one believes that Real M2 can signal a recession even after more than a year of improvement, then the precedent of 2007 exists, although just like the 1920s and 1930s, its turning negative was coincident with the onset of the December 2007 "Great Recession."



The increase in Oil prices now, and the relative weakness of wages, are not unprecedented. Yet several of the above leading indicators admit of no exceptions; others only one or two. For a recession to have already started, or even to start now or in a month or two, would represent an unprecedented constellation of exceptions to a host of indicators that typically lead directional changes in output, sales, and jobs by several months to over a year. This is why I am proverbially scratching my head at ECRI's certitude that a recession will begin by the end of June, and their defense of that call by use of a lagging construction of coincident indicators.

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Economic Indicators of the Roaring Twenties and Great Depression

- by New Deal democrat



I've been meaning to bookmark for future reference all of the posts I wrote in the last few months looking at economic indicators during the pre-WW2 deflationary era, and since it's a Sunday, now seems like a good time. Secondarily, there's an idiot at DK who is claiming that in my piece last week I neglected to look at indicators more than 50 years old, so my work is invalid, yadda yadda yadda - despite the fact that there was an entire section in that post devoted entirely to that era.



So, for the record, here are my prior posts discussing economic indicators from the period predating World War 2:



Professor Geoffrey Moore on Leading Indicators from 1854-1938



The Dow Jones Bond Average and pre-WW2 recessions



Real long term interest rates and pre-WW2 recessions



Money supply and pre-WW2 recessions



The yield curve and pre-WW2 recessions



Stock prices and pre-WW2 recessions



Commodity prices and pre-WW2 recessions



Housing starts as a pre-WW2 leading indicator



Corporate [BAA] bonds and pre-WW2 recessions



Economic Indicators during the Roaring Twenties and the Great Depression (V) (five part series examining the "Kasriel Recession Warning Indicator" of inverted yield curve and negative real money supply as applied to the pre-WW2 deflationary era).

So I'm pretty sure I know what I'm talking about.

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The data says: no double-dip recession

- by New Deal democrat



There has been a big scare reminiscent of last year as to whether the economy is about to enter, or even has already entered, a "double-dip recession." Although the Oil choke collar and Washington lunacy, along with a few other factors, have managed to bring the economy nearly to a stall, unless a foreign-origin contraction is sneaking in "under the radar" unseen even in LIBOR, EURIBOR, or TED spread rates, the simple fact is that the vast majority of the US economic data - including the majority of both modern and pre-WW2 deflationary era Leading Indicators - refute the notion that a recession has begun or is even close.



The NBER focus



In the first place, we know that a recession is actually called by the NBER, and we know that they focus of 4 data series - Industrial Production, employment, real retail sales, and real income. A fifth series, aggregate hours worked, is also important to at least one member. As of yesterday, we know enough to know that all five of those series are positive through July.



Here's employment, which has been positive ex-census for 17 months straight:







Real income continues to increase, albeit at a woefully inadequate pace:





Both nominal and real retail sales continue to improve. Although we don't have the July CPI report yet, it is not expected to come anywhere near the +.5% recorded in July retail sales:





Yesterday's industrial production report of +.9% maintains the solid upward trend of that series:





Finally, aggregate hours (blue) have continued to improve, and also continue to improve relative to payrolls (red):





Not one of the 5 series most critical to an NBER determination have turned negative. All 5 are still improving through July.



The 3 long leading indicators



There are 3 series in particular that function best as long leading indicators: housing, the yield curve, and the DJ Bond Index. A recession call gets no help from any of them, either.



According to Prof. Edward E. Leamer, housing has its biggest effects on the economy 12 to 15 months from a significant change. Here are housing permits for the last 5 years. There was a 75%+ collapse in housing permits between early 2006 and the bottom in 2009. With the help of the US and California housing credits, permits gained over 100,000 over the next year. When the programs ended in spring 2010, housing permits rapidly declined over 100,000, and continued a much slower decline for the rest of the year, before improving to the 600,000 level again very slowly this year. Prof. Leamer's research predicts that the maximum impact of the spring 2010 decline has arrived and is beginning to recede:







Since the 1950s, the yield curve has been a potent forecasting tool for a period about 1 year later. No recession in the last 50 years has begun without an inverted yield curve in the year prior. This includes the curve inversion of late 2006. In the below two graphs, the present yield curve (red) is compared with its flattest post-2006 reading, in December 2008 (left) and August 2010 (right). We know that within a year of the first reading a recovery was underway, and we know that as of the last revisions, positive GDP continued for at least close to a year after the second. There is no reason to believe the yield curve now is predicting anything worse.







Relying upon the yield curve, however, has come under some justified criticism given the zero bound on Fed interest rates. Indeed, the yield curve did not invert at any time between 1930 and 1954 despite the occurrence of the worst recessions in the last 100 years during that time (it did invert in 1928). In the case of pre-WW2 deflationary recessions, however, the Dow Jones Bond Average had a nearly perfect record, also turning negative about a year before those recessions. Here's what its modern version, the Dow Jones Corporate Bond Index, looks like now - it made a new eight year high last week:







The remaining modern leading indicators:



In all cases in the last 50 years, no recession began until at least 8 of the Leading Economic Indicators were below their levels of 6 month before. Here is a graph (ending in early 2009) of a 6-month diffusion index of the indicators:







The point of this index is that, to signal recession or recovery, at least 8 or 9 of the 10 indicators should all be moving in the same direction. The present record isn't even close. So far, only 3 -- ISM vendor performance, stock market performance, and consumer expectations -- may be negative for 6 months. Let's look at the evidence in more detail.



No recession in the last 50 years, has occurred without Real M1 (blue) turning negative, and Real M2 (red) being up less than +2.6% YoY. Real M1 has remained relentlessly positive, and after a sustained period under +2.5% YoY, Real M2 has also improved strongly in the last 2 months (in the graph below 2.5% is subtracted from M2):







Indeed, either the yield curve inverted, or Real money supply turned negative, before every single recession since 1920.



Additionally, "core" new durable goods orders have also continued to improve:







Perhaps more importantly, initial jobless claims, which had turned seriously negative from April through June, have completely reversed, and are approaching their late February - early April lows:







The manufacturing workweek has remained steady for the last 3 months:







In fact, only 3 of the 10 leading indicators have turned decisively negative, stocks:







consumer sentiment:







and vendor deliveries in the ISM survey:







Many regional manufacturing surveys, such as the Empire State survey released yesterday, are similarly negative.



Three out of 10 leading indicators turning negative is not enough to overcome the inference of continued economic expansion from the positive to neutral readings of the other 7.



Other leading indicators in pre-WW2 recessions:



Because both academic economists like Prof. Brad DeLong, and lay observers have voiced skepticism, even "alarm," that economic indicators developed from post-WW2 inflationary recessions, usually brought about by Fed tightening, may not be applicable to deflationary scenarios brought about by asset and credit contraction like the present, during the last several months I tested publicly available economic data series that go back to the 1920s at least.



Additionally, Prof. Geoffrey Moore, the founder of ECRI and the father of modern business cycle research, did publish a manuscript in 1961 discussing at length Leading Indicators for pre-WW2 recessions, available from the NBER via the St. Louis Fed. Indeed, some of his source data went all the way back to 1854. He found that they were valid indicators fir the post WW2 recessions as well. Here is his graph showing the most effective pre-WW2 leading indicators:







You can see that at least 4 of these are still in use today. Several others, including business failure liabilities and new incorporations, do not seem to be publicly available. Using the JJM ETF as a proxy for industrial commodities, the record is equivocal. After approaching their February 12 month high only 3 weeks ago, commodities have made a new 9 month low this week.



Additionally, another leading indicator he found, though not as effective as those above, was employment in manufacturing. Although there has been a steep secular decline in US manufacturing employment, in the last two years something very counter-trend has happened. Employment in manufacturing has risen, right up through July:







Additionally, another comparison that is available for data going all the way back to the 1920s is that of corporate bonds vs. long term government bonds. As a recession approaches, most usually yields on both decline, but government bonds significantly moreso than BAA grade corporate bonds, which carry more risk. As the recession actually hits, the series typically diverge, as BAA corporate bonds price in expectations of some defaults. This pattern was apparent going into the "great recession." While there was a slight divergence in the last several months, it was not that significant, and in the downdraft in yields last week, it completely disappeared:







The Oil choke collar



Finally, I would be remiss if I did not include a discussion of the Oil choke collar. Every time the price of energy has exceeded 4% of GDP, a recession has occurred. We have breached that level this year:







A little explanation is in order. The left scale is set to show the divergence in price from Kopits' inflection point of 4% of GDP. Thus the left scale result, n, equals 4 minus Oil price/GDP. If Oil price =5% of GDP, then N = 4-5= -1. Contrarily, if Oil price = 3% of GDP, then N = 4-3 = +1. Also note that since the graph had to be done quarterly, it does not reflect the decline in Oil prices since June 30 (all the way down to $76 and currently about $86).



As you can see, since the price of Oil approached the inflection point in 2005, it has predicted GDP changes very well. And it does not bode well for revisions to Q2 2011 GDP or the third quarter either.



One important difference, noted by Prof. James Hamilton of UCSD, is that this time around, there has been less of a "shock" since consumers did see these prices 3 years ago. Consumers have thus not over-reacted, as has been demonstrated all year by strongly positive retail sales reports.



Thus, while high energy prices have shown up in some of the stalling data above, they do not necessarily imply a contraction. At least, they have not bled broadly over into other data series as they have before every other oil-induced recession.



Conclusion



There is no doubt that the economy is under serious stress. Manufacturing, which had been leading the recovery, has completely stalled, and in at least a few regions, may actually have contracted slightly. Nervousness about a financial seize-up reminiscent of 2008, and a fundamental loss of confidence in Washington panicked the markets (as well as consumer confidence) in the last several weeks. Oil continues to act as a choke collar on economic growth.



But the simple fact is that the current data does not make out a case that either a double-dip recession has started, or is imminent. Most of the domestic US economic data remains solidly positive.

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Prof. Geoffrey Moore on Leading Indicators from 1854-1938

- by New Deal democrat

Both academic economists like Prof. Brad DeLong, and lay observers have voiced skepticism, even "alarm," that economic indicators developed from post-WW2 inflationary recessions, usually brought about by Fed tightening, are applicable to deflationary scenarios brought about by asset and credit contraction like the present. In response to that, for over a month I have been testing publicly available economic data series that go back to the 1920s at least.

But did the founder of ECRI, and the father of modern business cycle research, Prof. Geoffrey Moore, leave behind no public record, in particular a record discussing Leading Indicators for pre-WW2 recessions? It turns out he did, in the form of a very thorough 1961 manuscript, available from the NBER via the St. Louis Fed, in which he identified and discussed Leading Indicators from the pre-WW2 period (as to some of which data went all the way back to 1854) and tested them to see if they applied to the post war recessions of the late 1940s and 1950s. They did.

The meat of his discussion is found in Chapter 3 of the manuscript, from which the following quotes are taken.

Prof. Moore summarized the study and its results as follows:

Before the war, in 1937, Wesley Mitchell and Arthur Burns picked a set of twenty-one indicators from among the several hundred time series that the National Bureau had analyzed in its study of business cycles. [NDD note: Mitchell and Burns' 1937 manuscript is here] After the war I undertook to redo the job and in 1950 published a new list of twenty-one indicators. They are classified in three groups— leading, roughly coincident, and lagging—according to their tendencyto reach cyclical turns ahead of, at about the same time as, or later than business cycle peaks and troughs. Many of the series in my list were either identical with or closely related to those in Mitchell's and Burns' list, but I omitted some that seemed redundant or of dubious value, and added some on the basis of new information. But both their study and mine were based on prewar information about the cyclical behavior of the data. The experimental part of the project consists in seeing whether this prewar information provided a useful guide to the postwar behavior of these data in relation to business cycles.
....
Most of the prewar relationships exhibited by the twenty-one indicators have survived a great many years and a wide variety of so-called "structural" changes in the economy. .... [T]he only series that should be shifted would be personal income, retail sales, and corporate profits. The first two now appear to be better classified in the roughly coincident group, and the third in the leading group. .... The other series have all behaved in a manner consistent, or at least not inconsistent, with their prewar record

(emphasis supplied)

Comparing his list with the 1937 list, Prof. Moore noted that:

[O[f the twenty-one indicators selected by Mitchell and Burns in 1937, only [two are] on our new list [of leading indicators]: business failure liabilities ... and average workweek in manufacturing

Prof. Moore categorizes the themes of the data series that proved useful as Leading Indicators as follows: (1) sensitive employment and unemployment indicators - in particular, hiring and firing in manufacturing, (2) commitments to new investment, (3) business profits and failures, and (4) inventory investment and industrial commodity prices.

He found that, as to the comparison of the postwar [WW2] with the indicators selected on the basis of prewar records did show that "What is significant, and encouraging, is the fact that the postwar record is substantially the same as the prewar record."

Here is Moore's list of Leading Indicators from the era before WW2, showing their typical leads in pre-WW2 recessions, and showing their continued viability thereafter, first as to economic peaks:



And here it is as to troughs:



Note that 4 of the leading indicators from the pre-WW2 era -- housing starts, stock prices, new orders for durable goods, and the manufacturing workweek -- are still on the list of 10 LEI's today. This should give us a great deal of confidence that what they show now is as valid as what they showed in the last 100 years and beyond.

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Corporate bonds and pre-WW2 recessions

- by New Deal democrat

One of the items I always list in my "Weekly Indicators" column is BAA corporate bond yields. Since yesterday I wrote about the existence of economic indicators in the pre-inflationary era before WW2, it's worth revisiting that data, including BAA corporate bonds,because one of the reasons I added it to my list is precisely because we have good data on corporate bonds (both AAA and BAA) for almost a century - since 1919. BAA bonds have shown more reaction to economic conditions, so that is the series I track.

Here is the graph of BAA corporate bond yields from 1919 through 1941:



Note that, with the sole exception of the 1927 recession, BAA (i.e., lower grade) corporate bond prices began to fall, and their yields rise, in advance of the onset of a deflationary recession, and then continued to rise as corporate creditworthiness became more risky during the recessions. BAA corporate bond yields also typically began to decline in advance of the end of the recessions. In short, they functioned as a leading indicator.

Now let's look at BAA corporate bonds for the last 10 years. Note that there is the same pattern in advance of and during the "great recession" of 2007-09. BAA corporate bond yields began to rise in 2005 and continued to rise as risk of corporate defaults increased during the recession. Yields declined in advance of the bottom of the "great recession" in 2009. Once again, they functioned as a leading indicator.



Now, take a look at the far right end of the graph above, showing 2010 and 2011. Do you notice the rising bond yields in anticipation of worsening corporate creditworthiness?

No? Well, neither do I.

Publicly available leading economic indicators from the pre-inflationary era are not non-existent. Over the next week, time permitting, I'll post some more series that go all the way back to the 1920s or even 1910s.

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Leading Indicators Up .4

From the Conference Board:

Says Ataman Ozyildirim, economist at The Conference Board: “The U.S. LEI continued to increase in March, pointing to strengthening business conditions in the near term. The March increase was led by the interest rate spread and housing permits components, while consumer expectations dropped. The U.S. CEI, a monthly measure of current economic conditions, also continued to rise, led by gains in industrial production and employment.”

Says Ken Goldstein, economist at The Conference Board: “The U.S. LEI continues to point to sustained economic growth through year end. Global disruptions, including unrest in the Middle East, rising oil prices and the Japan earthquake, may have some repercussions. However, it remains to be seen what the impact of these shocks will be on the United States and the broader global economy.”

Take a closer look at the underlying data:

Click for a large image

While the overall index is up, there are a few points about the data that is concerning.

1.) The average workweek is barely up since last September. Consider that data in light of this chart of the Index of Aggregate Weekly Hours of Production and Non-Supervisory Employees

The total dropped hard during the recession and is still barely recovering, indicating there is still tremendous slack in the labor market that employers can access before adding a bevy of new employees.

2.) Manufacturers new orders for non-defense goods tumbled last month. Consider that in light of the larger durable goods picture.

3.) M2 dropped slightly and the interest rate spread came in slightly.

4.) Consumer expectations took a tumble and accounted for a large percentage of the negative side of the LEI equation. This is probably the result of fuel prices. Here is more information on the situation:

Amid rising gas prices, stubborn unemployment and a cacophonous debate in Washington over the federal government’s ability to meet its future obligations, the poll presents stark evidence that the slow, if unsteady, gains in public confidence earlier this year that a recovery was under way are now all but gone.

Capturing what appears to be an abrupt change in attitude, the survey shows that the number of Americans who think the economy is getting worse has jumped 13 percentage points in just one month. Though there have been encouraging signs of renewed growth since last fall, many economists are having second thoughts, warning that the pace of expansion might not be fast enough to create significant numbers of new jobs.

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A Note on the Leading Economic Indicators

- by New Deal democrat

As I have frequently pointed out, the KISS method to be right about the economy over the next 3-6 months is simply to follow the LEI. In the past it has been documented that you won't always be right, but you'll be right a lot more often than those who claim to engage in fundamental analysis" or simply rely on what other pundits say.

H/t to Briefing.com, here is the LEI for the last 24 months:

As you can see, they were already in steep decline in July 2008, two months before the "Black September" crash in the economy. They turned up in April 2009, 3 months before the economy as a whole bottomed. For the last four months, the best way to read them in terms of the immediate future is, converging on zero. Typically it is said that a decline in the LEI of three straight months signals a recession: we simply aren't there yet.

Additionally, here is a screenshot, again from briefing.com, of the reading of each indicator for the last 5 months:

Once again, you would be hard put to discern a trend in any one of those indicators. In any given month, a random member of the group is decisively up or down, and has not moved continuously from month to month. Again, what we see is, convergence on zero.

Finally, here is a graph (ending in early 2009) of a 6-month diffusion index of the indicators:

The point of this index is that, to signal recession or recovery, at least 8 or 9 of the 10 indicators should all be moving in the same direction. We are nowhere near that yet. So far, only 3 -- ISM vendor performance, building permits, and consumer expectations -- may be negative for 6 months. Stock market performance is on the edge. Initial claims may well have tipped as well, as of yesterday.

But that simply does not signal recession, rather than a slowdown, yet.

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Harbingers of the Second Half Stall

- by New Deal democrat

Besides posting here, Bonddad and I not infrequently have phone conversations about the markets and economy (I know, you're shocked). Over the weekend, I noted that almost all of the data started to head south at precisely the same time -- late April. Commodities, stocks, bond yields (more on that below), mortgage applications, the index of leading economic indicators, YoY CPI -- all appeared to stall or began to decline at almost the exact same time.

In fact, here is a graph I posted at the time of ECRI's leading index, which had been on a tear for a year (following their gutsy and correct call that the Great Recession would bottom last summer). As of mid-April, it had slowed from white hot to red hot -- still showing better growth ahead than at any time since 1983:

And yet, 45 days later it had crashed into negative territory:


Unless we are to believe that we will have blazing growth for the next few months and then hit a wall, an index that plummets that fast in 45 days has a problem. Of course, I should qualify that by noting that the we did actually have non-census job growth in both May and June, and real income has been increasing, as has industrial production. So the coincident incidators are still going up. It is really all of the short leading indicators (I include real retail sales in that group) that seemed to simultaneiously roll over.

Because we are living in the first deflationary environment in 70 years, we have no idea how most data series perform. There is monthly data from the Roaring Twenties and the Depression Era in a few areas: commodity prices, bond yields, and money supply for example; but the rest was kept on an annual basis if it was collected at all, which is not much help for forecasting or policy analysis. Back when I looked at that data almost two years ago, I did find some trustworthy indicators, but they were frequently coincident or just slightly leading (mainly money supply). I also found comparing YoY commodity vs. consumer changes in prices of some help.

In any event, here are the series I found that rolled over before April, and so are worthy of watching more.

1. The Shanghai stock index.

As Bonddad reiterated yesterday, China now unequivocally leads. It is the global locomotive -- and American consumers are the caboose. As with the US in the late 19th and early 20th Centuries, China is a vast bellows, ultimately blowing hot and cold upon the world's resources. It's stock market now appears to lead the rest. Here is the Shanghai stock index for the last 3 years compared with the S&P 500:

There is simply no question that during that time, Shanghai has been the leader. And it is not comforting that it has not turned back up.

2. Bond yield correlation with stock prices

During the disinflationary 1980s and 1990s, bond yields and stock prices moved in opposite directions. That changed beginning in 1998, and generally speaking, continues now. Bond yields and stock prices have generally moved in the same direction, signalling the pre-eminence of DEflation as a concern. During the 2003-2007 expansion, within that range they did move as mirror images, however. They resumed moving in lockstep shortly before the December 2007 downturn, before resuming mirror image movements in the latter part of 2009.

Beginning last December, the stock market and bond yields again resumed moving in the same direction:


This began at the time of the Dubai sovereign default scare, as bond traders worried (or salivated) over who would be next, and began to focus on Greece. Once again, deflation had moved to the fore. By the way, here is how the same graph looked in late 2007 and 2008:



3. Price growth exceeded wage growth

During the disinflationary/asset bubble period, consumers could either cash out appreciating assets (stocks, housing), or refinance at lower interest rates. No more. Consumers can only spend by building up savings, or if wage growth exceeds inflation. In 2009, wage growth was far in excess of deflation. That changed at the beginning of this year, as mainly due to the price of Oil, YoY inflation again exceeded YoY median wage growth:

Real spending growth in that environment can only happen by tapping savings, and after 2008, that was going to be very limited. This is a modern confirmation of the trend I noted above about commodity prices and consumer inflation from the Roaring Twenties and Great Depression era.

4. Oil prices approached 4% of GDP and 6% of consumer spending.

Back in January, I predicted a second half slowdown due to increased energy prices. It was disconcerting that they had immediately risen past $75/barrel so soon after the turnaround from the deepest global decline since the Great Depression. So long as the economy improved, it seemed sure that Oil prices would continue to increase as well, until they acted as a choke collar on growth. They indeed did so:

They just grazed the 4% threshold of GDP/6% threshold of consumer spending in April. While Oil prices themselves peaked in April along with nearly everything else, it appeared obvious in January that they would trigger a slowdown or reversal sometime this year.

5. Money supply stalled or shrank

This is another area of confirmation of indicators from the Roaring Twenties and Great Depression. After rising briskly for over a year, at the beginning of this year, real M2 began to decline and real M1 stagnated:

The M2 decline was the chief reason for the tailing off of increases in the index of Leading Economic Indicators. Recessions have typically been accompanied by real M2 growth of less than 2.5%, and real M1 declining. We have the first, which may be turning around now. The second has not occurred.

6. Housing permits and purchase mortgage applications

The MBA's index of purchase mortgage applications peaked last November just before the original expiration date of the $8000 home buying credit. Despite the secondary peak in April, it has been generally in decline since:

Similarly, housing permits peaked in December and again in March. Housing permits have been the second biggest source of the tailing off of the advance in the LEI, and most likely the MBA purchase mortgage index has been the primary source of the steep and sudden decline in ECRI's index. Housing is a classic "long" leading indicator, and on an annual basis, did lead the 1929 decline by several years, and bottom in 1933.


That's my list. These 6 items have shown that they bear further watching (and generally I do in my "Weekly Indicators" wrap-up). If anybody knows of anything else, feel free to add it to the list in Comments.

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