Posted on | August 20, 2010 | No Comments
Nobel winning economist Paul Samuelson quipped in 1966 that “Wall Street indexes predicted nine out of the last five recessions.” Are they any better today? Are the really leading, or are they misleading indicators? An IMF study of 63 countries said that (quoted here) “The record of failure to predict recessions is virtually unblemished.”
Commentators such as this and this and this and this don’t think think the leading indicators lead very well. The Conference Board’s leading economic indicator, which is supposed to predict economic activity one or two quarters in advance, is heavily weighted to manufacturing. The money supply (M2) gets the largest weight. Does such a composition of the index make sense with the shift to a service rather than a manufacturing base, and massive government injections of liquidity?
What evidence is there that the so-called leading indicators actually lead? Does Samuelson’s criticism apply today to the Conference Board’s Index of Leading Economic Indicators? A simple test is to compare the leading economic indicator advanced one quarter with GDP numbers, as done in this graph (source):
As the above chart shows, there are occasionally big drops in the indicator, without corresponding drops in GDP, or recessions.
Another leading economic indicator, this one produced by the Economic Cycle Research Institute (ECRI), shows a similar mismatch between the indicator and recessions. It suggests, according to this Wall Street Journal post, to another recessionary dip in the months ahead, rather than the anemic growth foretasted by the Conference Board’s indicator:
Yet even the ECRI’s leading indicator comes under some pretty severe criticism about its ability to forecast. And ECRI’s managing director downplayed the WSJ’s gloomy interpretation of its indicator (quoted here). ECRI also says their indicators do not mislead, they are misunderstood. Their conclusion (back in June) was that ”a slowdown in U.S. economic growth is imminent, but a new recession is not.” Hmm……
Looks like Samuelson is still right.