The following was written by Lakshman Achuthan and Anirvan Banerji, co-founders of ECRI:

~~~

“As Geoffrey H. Moore once reminded us, if you can ‘predict’ a recession just as it’s beginning you are doing very well as a forecaster.” We recalled our mentor’s observation in our book, Beating the Business Cycle, and it’s just as relevant today as it ever was.

With the economy slowing, the double-dip recession debate has naturally assumed center stage. Perhaps you already know something about the Economic Cycle Research Institute (ECRI) or the Weekly Leading Index from your favorite analyst, commentator or blog. But, as debates go, this one is becoming heated and ECRI is being misrepresented more often than not. We write this note in an effort to address the more extreme misperceptions.

Recent diatribes from investment managers with blogs have culminated in an accusation that we are dishonest when it comes to ECRI’s forecast track record in the lead-up to the 2007-09 recession. Having ECRI’s forecast challenged is nothing new, but we’ve never had our professional integrity called into question, until now. Criticism of our work comes with the territory, but such charges do not. Therefore we ask you to consider what’s been left out of that narrative and, more importantly, why. Inquiring minds would surely investigate before accepting such character assassination.

One would find that the facts are willfully misrepresented, perhaps in an attempt to undermine ECRI’s credibility when expedient. Our detractor’s declaration is based on a cherry-picked quote from a PowerPoint file (including discussion notes) that we posted on our website on October 5, 2009. Ten months later, on Aug. 4, 2010, the charge was that “ECRI is caught” in an “Outright Lie,” saying that we claim to have forecast the recession in November 2007. This is simply made up.

Evidence offered to support this allegation resides on the third slide of 23 from an October 2009 ECRI presentation titled The Great Recession and Recovery. That slide shows our Weekly Leading Index (WLI) and includes an ECRI discussion note for the presentation saying that the WLI has been around for over a quarter century and that “it has correctly predicted every recession and recovery in real-time.”

In fact, that statement is undeniably true. The WLI peaked and went into a cyclical downturn six months before the recession began. So this is hardly a smoking gun.

In evaluating the performance of any leading indicator, the key question is whether its cyclical turn occurred before the cyclical turn in the economy. If so, the follow-on question is whether that lead occurred in real time, or showed up only in revised data. In the case in question the WLI peak occurred well before the business cycle peak, in real time. That was the point of that slide.

But, nowhere on the slide in question does ECRI claim to have predicted the recession. Nowhere do we equate ECRI to the WLI. To the contrary, a few slides later, we say that ECRI called the recession in March 2008. It’s inconceivable that anyone attending the actual presentation, or reviewing the presentation in retrospect, could come away believing otherwise.

To be clear, our detractors are capable of understanding what we’ve been saying all along. On July 20, 2010 they wrote:

“I suppose you can see how confusing this is when the WLI ‘has correctly predicted every recession and recovery in real time’ yet Lakshman Achuthan also says … ‘In fact, at the very least, ECRI itself would need to see a ‘pronounced, pervasive and persistent’ decline in the level of the WLI (not merely negative readings in its growth rate) following a ‘pronounced, pervasive and persistent’ decline in ECRI’s U.S. Long Leading Index (not discussed in the article), before it makes a recession call.’ That is a clear statement that the WLI cannot in and of itself predict anything unless it follows the ECRI’s U.S. Long Leading Index.”

That focus on our “clear statement” is correct. In fact, ECRI interprets the WLI in the context of our full array of leading indexes (including the Long Leading Index) as outlined in chapter seven of Beating the Business Cycle (Doubleday, 2004). And yet, these critics try to malign ECRI by conflating the WLI’s movements with ECRI’s recession calls.

The Whole Truth

Just go to The Great Recession and Recovery, which provides a clear timeline of ECRI’s forecasts from the fall of 2007 through summer 2009. We encourage you to examine the full presentation firsthand, but here are the pertinent slides from that presentation, starting with the third slide:

click for larger charts

1. Weekly Leading Index

This is an index that’s been around for over a quarter of a century, and over that time (shown here) it has correctly predicted every recession and recovery in real-time. I need to repeat that, over this entire time period, I was present to see each of the correct recession and recoveries calls in real-time, without false signals in between… Please note the WLI peaked in June 2007, six months before the recession began.

2. Recession Warning

And we issued a clear Recession Warning noting that: “The magnitude of oil and interest rate shocks are near recessionary readings.” A month later, as we now know, the recession began.

3. Weekly Leading Index Growth Rate (%)

Here’s where that point in time is in terms of the WLI growth rate — which had become the most negative since the 2001 recession (see red arrow). And we wrote at the time…

4. On the Cusp of Recession

…that we were on the cusp of a new recession. “The breadth of deterioration evident in the latest data on the components of ECRI’s many leading indexes has rarely been seen except near the cusp of a recession.” …A month later in January 2008 we ratcheted up the alarm even further.

5. A Self-Reinforcing Downturn

We wrote that, “A self-reinforcing downturn has already begun.” And by March 2008 we had clearly crossed the point of no return.

6. “A Recession of Choice”

Policy makers had acted in a so-called “bold” fashion, but they had done too little, too late to avert a recession. As a result we were in what we called “a recession of choice” and we wrote: “(ECRI’s leading) indexes have unambiguously turned onto the recession track.”
~~~

After reading these slides would you really be left with the impression that ECRI claims to have called the recession before March 2008? We don’t think so. Yet if you only saw carefully selected “snips,” while critical parts were withheld, you might understandably begin to doubt ECRI’s honesty.

An aside: why did ECRI hold off on calling recession until March 2008? That’s a whole other story, but we believed at the time, as we believe today, that the recession didn’t have to begin or evolve the way that it did.

Stepping back, it’s important to note that this presentation was hardly the only place where we discussed our recession call in retrospect. Take a look, for instance, at our Oct. 2, 2009 article, prominently displayed for months on our website, which explicitly identifies March 2008 as our official recession call date. There’s no doubt about when we say we made our recession call.

Furthermore, that same article emphatically disproves another line of criticism from naysayers: that ECRI is so scared to make recession calls that by the time we make them they’re useless. To summarize our article, even if you were to be as simplistic as to sell stocks when ECRI says recession and buy stocks when we say recovery, those would be very valuable calls. Here’s what would have happened over the past cycle:

A Measure of Value

If you sold the S&P 500 the day we made our “late” recession call in March 2008, you’d have sidestepped 72% of the cyclical bear market decline (from the October 2007 high to the March 2009 low). Then, if you had bought stocks on the very day in April 2009 we made a recovery call, you’d still have enjoyed 64% of the cyclical bull market in stocks (from the March 2009 low to the April 2010 high) – not bad considering that the first 25% of that rally occurred within two weeks of the market bottom.

If instead you’d had a buy-and-hold strategy for stocks, then at the April 2010 market peak, you’d still be down 16% compared with the October 2007 market peak. But if you’d sold stocks the day we said recession and bought stocks the day we said recovery, you’d be up 39% since October 2007, beating the S&P by 55 percentage points.

Finally, on February 5, 2010, we discussed a chart of the Long Leading Index on CNBC, highlighting the risk of a new downturn in stock prices, which began just two months later. Just how much more does a free service have to do in order to be deemed useful?

Now, please understand that ECRI will never be perfect, and, in any case, we aren’t in the business of making market calls. So, why would some people go to such lengths in an attempt to undercut our credibility? We don’t know, but in this case a search of the fund manager’s blog shows that promotion or criticism of our work seems to depend on whether we reinforce or challenge his views.

Cycles of Credibility?

For example, on Oct. 18, 2008, the WLI and ECRI are held up as supporting evidence for a pessimistic view of the economy with headlines like “Leading Indicators at 33 Year Low,” going on to quote us directly: “With its biggest weekly plunge in 37 years WLI growth has dived to a new 33-year low. This data objectively shows that financial market turmoil is rapidly worsening an already-grim recessionary outlook.”

But a year later, after ECRI forecast a recovery, our views are no longer validating the pessimistic consensus and are therefore suspect – as seen on Oct. 8, 2009, with headlines like, “Can We Really Trust The Leading Economic Indicators?” There followed a list of statements we had recently made about the upturn such as: “With WLI growth continuing to surge through late summer, a double dip back into recession in the fourth quarter is simply out of the question.” (Aug. ’09)

The investment manager went on to share his newfound skepticism: “…what I suspect but cannot prove, is the LEI or WLI (Weekly Leading Index) criteria applied to data in 1930 would have shown something that did not happen: a big recovery was coming.” Then by May 28, 2010 there is a switch back to once again promoting the WLI: “ECRI Leading Indicators Dip Again; Is a Double-Dip Recession Coming?

If you look at the history, there’s a clear lack of consistency in these arguments. But this is just one example of attacks on ECRI. Far more important is a broad misunderstanding of what ECRI is all about. Where does that come from?

Confirmation Bias

A big part of the “problem” may lie with ECRI’s impressive track record.

Those with a bullish or bearish agenda may be threatened when ECRI or the WLI makes – or seems to make – a call that challenges their views. As we saw a few months ago, when the WLI moves in a way that reinforces the views of one camp and contradicts the views of the other, the former group (in this case, the bearish camp) extols its accuracy while the other (in this case, the bullish camp) tries to explain it away or find flaws with the WLI itself.

Last fall it was this need to challenge ECRI, given its track record, that drove Paul Krugman to applaud an investment manager’s “awesome takedown” of ECRI. Overcoming ideological differences, they were patting each other on the back for impugning our track record.<
Because the respective agendas of these otherwise strange bedfellows required the U.S. recession to persist, ECRI’s economic recovery call stood in their way. At the time, we defended ourselves in detail, and requested Mr. Krugman to acknowledge the correctness of our call if, a year later (i.e., two months from now), ECRI was proven right. Despite four straight quarters of positive GDP growth and seven consecutive months of positive private sector job growth thus far, we’d be surprised if he ever admits the accuracy of our forecast.

In defense of his views, and in an apparent attempt to undercut the credibility of ECRI’s forecast, Mr. Krugman wrote at the time that “this is a really, really bad time to be relying on conventional indicators… historical correlations, to the extent that they exist… can’t be counted on to prevail.” Please make note of this critique, because there are many variations on this theme, rooted in a fundamental misunderstanding of ECRI’s indexes and methods shared by the overwhelming majority of observers.

There are a number of valid ways to describe ECRI’s leading indexes, but “conventional” is not one of them. In fact, the implicit suggestion that the WLI cannot be relied upon because “historical correlations… can’t be counted on” is revealing, and completely off-base – because the construction of ECRI’s leading indexes isn’t rooted in historical correlations or regressions, or in the back-fitting of data. This seems incomprehensible to most conventional economists – monetarists, Keynesians, and everybody in between – because the pseudo-science of econometrics is the only analytical approach they’ve ever been taught. Very few of our critics (or admirers, for that matter) appreciate the fact that we don’t use models because they are singularly unsuited to business cycle analysis – even though we’ve said this six ways to Sunday.

Thus, some critics question our work based on their belief that “historical correlations” wouldn’t prevail in this cycle, unaware that this wouldn’t affect the performance of our indexes, since they aren’t fitted to back data anyway. And detractors, implying that our indexes must have been fitted to the postwar period, suspect that the “WLI criteria applied to data in 1930 would have shown something that did not happen: a big recovery was coming” – unaware that, while the WLI goes back only to 1949, other ECRI leading indexes, including the U.S. Long Leading Index, work very well in the 1930s and earlier decades in predicting recessions and recoveries – without any attempt at data fitting.

When we make such statements, they are typically ignored or met with a wall of disbelief. Indeed, conventional economists – which is to say, virtually all economists – have so thoroughly embraced the “scientific” model-based approach to economic analysis that it’s hard for them to imagine that any other approach could possibly exist.

Physics Envy

At this point we are reminded of Friedrich von Hayek’s trenchant critique of economists’ analytical methods during his 1974 Nobel lecture: “It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the ‘scientistic’ attitude – an attitude which, as I defined it some thirty years ago, ‘is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.’”

This “physics envy,” as we explain in Beating the Business Cycle, is the nub of the matter. While model-based approaches to analysis are often appropriate in the hard sciences, they aren’t always suited to economics, and are singularly inappropriate for the analysis and prediction of business cycles, which are rooted in a highly complex non-linear system, with myriad feedback loops, lags, threshold effects and diffusion processes, that are virtually impossible to specify properly in the context of a constantly evolving global economy. A model optimized to fit a specific past time period will not only be sub-optimal for the future, but also result in highly inaccurate forecasts if economic conditions are very different from those for which the model is optimized. Moreover, if linearized models are used, as is often the case, in place of more appropriate but statistically intractable non-linear models, the model specification errors may result in wildly inaccurate forecasts.

Because our research group is keenly aware of these issues, we have always eschewed a model-oriented optimization-based approach to business cycle forecasting. ECRI’s focus has always been on robustness, i.e., making sure our leading indexes’ turning points consistently anticipate the economy’s turning points, even in the face of major structural changes. This has been the secret of ECRI’s long-term success, and the reason why our leading indexes once again turned down months before the Great Recession in 2007, and turned up before the recovery in 2009 when the overwhelming consensus was dead against an economic recovery forecast.

But our approach is also inconsistent with recently popular notions – once again based on conventional back-fitting of data – that, somehow, when the WLI growth rate hits a specific negative number, a recession always follows. Firstly, it’s the WLI itself, not its growth rate (i.e., its speed of descent), that’s designed to predict economic recession and recovery. Secondly, historical data going back six decades shows that the nice round number of minus 10% doesn’t work too well anyway as a recession signal. But, most importantly – regardless of unfounded accusations that we’ve “abandoned” our own indexes just because we distance ourselves from these simplistic data-mining exercises – the whole idea is fundamentally flawed. In other words, it’s a bit naïve to believe that some variety of data fitting based on conventional statistics using the WLI will tell you how to predict recession and recovery – especially if, as our critics never tire of asserting, it’s different this time.

To add to the confusion, there’s a belief in certain quarters that some of the most prominent analysts who’ve highlighted the WLI also have access to ECRI’s Long Leading Index (LLI), which looks further ahead. Let’s be clear: they don’t. And some who’ve tried to guess the LLI’s moves based on what they know of other leading indexes have also been way off base.

Separately, few analysts crunching the WLI data realize they shouldn’t be using the WLI in regression models – to make GDP forecasts, for instance. To cite a classic textbook[2] on forecasting, leading indexes – including the WLI – are “intended only to forecast the timing of turning points and not the size of the forthcoming downswing or upswing, nor to be a general indicator of the economy at times other than near turning points.” It therefore warns against using “standard statistical techniques” to draw inferences from leading indexes.

While such techniques require certain assumptions, ECRI’s approach – unlike econometric models – makes virtually no assumptions that could be invalidated. This is a great advantage in “unusually uncertain” times. Yet, by sidestepping models, we also constrain what we can predict. Keenly aware of the limitations of our tools, we focus on turning point forecasts – not magnitude forecasts – whether about GDP growth or the jobless rate. This is also why we avoid advocating or decrying any specific policy measure, except rarely, in the narrow context of policy timing.

A key danger of being wedded to any particular ideology or market view is confirmation bias – the tendency to selectively focus on evidence supporting what one already believes or wants to be true. The resultant lack of objectivity is an enemy of forecast accuracy. That’s why we don’t belong to any particular “camp,” accusations notwithstanding. When our objective leading indexes change cyclical direction, we change our view about the economy’s direction, period. As a result, we find ourselves being alternately feted and reviled by liberals and conservatives, bulls and bears, while we stick to our knitting.

As Good as It Gets

Predicting the economy’s turning points is really hard, and we know that we’ll inevitably make mistakes. That’s why – instead of developing back-fitted models – the entire thrust of ECRI’s research over the decades has been to stress-test our leading indexes under a variety of structural conditions in dozens of economies, understand the conditions under which the approach would break down, and design a durable system of indicators that’ll keep working even under unusual circumstances.

Sure, there are many questions about the economy our tools don’t help us address. For instance, based on our leading indexes we couldn’t tell you what the economy will be doing in the second half of 2011. Dr. Moore taught us that we shouldn’t try to “predict the predictors,” and we’ve learned over the years that he was right. In such a complex economy, we simply aren’t smart enough to know which way they’ll head. What we can do is to closely monitor our array of leading indexes, knowing that they’ve rarely led us astray.

ECRI isn’t in competition to be the first to proclaim recession or recovery. But we strive to make our objective turning point calls both highly reliable and timely enough to be useful to decision makers.

We also spend a good deal of time thinking about the broad backdrop against which these shorter-term cyclical fluctuations occur, and in early 2009 these thoughts brought us to the inescapable conclusion that this decade will see more frequent recessions than most of us remember. These frequent recessions will result from the convergence of higher cyclical volatility and lower trend growth during expansions.

Keeping this in mind, please understand that ECRI’s approach to leading indicator analysis is designed to ensure that our leading indexes are robust enough to function accurately even in unusual economic environments, like we have today. Regardless of ad hominem personal attacks, coupled with confusion about how to interpret ECRI’s leading indexes, ECRI’s disciplined and objective approach to economic cycle forecasting is the most reliable method we know about, for signaling recessions and recoveries.

On Jan. 25, 2008 we publicly described the opportunity to forestall the recession, “A Window of Opportunity” and then on Mar. 28, 2008, we described how that opportunity had been missed in “A Recession of Choice”.

Forecasting Economic Time Series” by C. W. J. Granger and P. Newbold (Second Edition, 1986), New York: Academic Press.

Category: Cycles, Economy, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

33 Responses to “SCIENTISTIC FICTION”

  1. TBP Editor says:

    I am adding the slides manually — should be up in 15 minutes

    Slides are posted

  2. AHodge says:

    lakshman
    nice, always read your stuff.
    timely, as i debating right now with bunch of Global Insight alums on this
    about 1/3 got it roughly right, like you—- about one third say
    how could we have known? models cant call recession turning points?
    what ECRI did was anticipate well, and mostly from nonfinancial economic leaders
    Without building in EXTRA from the expected lagged effects of credit starvation and the shutdown of securitization.

    If you saw that coming, it was mostly a one-off gut instinct, as there no modelling relation i know of postwar

  3. NoKidding says:

    A respectable response to the criticism that addresses the real issues.

    The only missing element is a statement about where we are in the business cycle right now (not this decade, this quarter). I am left with the impression ECRI thinks the 2009 recovery is still on, but that we may see several more recessions before 2020.

  4. genevakiwi says:

    What point is there in having an “index that’s been around for over a quarter of a century, and over that time (shown here) it has correctly predicted every recession and recovery in real-time” if the creators of the index refuse to explain the construction and their interpretation of said index in real time, finally calling a recession in March 2008…4 months after it actually started and a full 8 months after the index turned down predicting it?

    Are the creators simply trying to beat the NBER in dating the recession or actually trying to predict it?

  5. dwkunkel says:

    Show us the code and the arguments end.

  6. mgnagy says:

    Sorry, I couldn’t get past the first sentence of the second paragraph:

    “With the economy slowing, the double-dip recession debate has naturally assumed center stage.”

    The economy is not slowing, it has _changed_. As for talk about a double-dip recession, the economy must first get out of the first dip.

    Or is this all about shoring up “conventional wisdom” for those working their way through the last of their single malt…

  7. powersjq says:

    This is just long-winded nitpicking. The WLI seems to be indicating a recession, but ECRI hasn’t yet called one. That was the original question. When ECRI started getting defensive, suspicions replaced questions. ECRI has simply mishandled this from the outset. ECRI bills its index as a reliable predictor of recessions, then seems to want to tread lightly with its interpretation of the current dip in the WLI. Complaints that such interpretation is a dicey and delicate thing belie the robustness of the indicator. Can’t have it both ways.

  8. Mannwich says:

    I’m still not convinced that the most recession ever really “ended”. Sorry.

  9. constantnormal says:

    @Mannwich

    — it ended when the last remaining occupant of the middle class stepped down to being at best, “upper-lower”. We are in a “new normal” now.

    At least, that’s how I interpret that phrase. We are in a budding banana republic. Look for bars for your windows at the next garage sale of people downsizing their “stuff”, or hire an out of work construction worker to steal some rebar and build you a set.

  10. junkndump says:

    Thank you for reminding us all of von Hayek’s comment, it deserves repeating:

    ““It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the ‘scientistic’ attitude – an attitude which, as I defined it some thirty years ago, ‘is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.’”

  11. Mannwich says:

    Agreed, constant, but it will be a long slow, decline, an engineered one into a “soft landing” (for the elites, not masses), if you will.

  12. Mannwich says:

    In fact, without the credit/housing bubble, reckless gov’t policies aiding and abetting said bubble, and mass criminality on Wall Street, we likely wouldn’t have come out of the recession from ’00. Now they’re out of those bullets to bring us out of this one. What now?

  13. Casual Observer says:

    Mannwich – you are completely correct about that. That’s why I call this the secular recession of the 2000s. It started in 2000-2001 and never really ended. The underlying secular changes and themes are firmly in place (lower incomes, lower growth, reduced employment, high unemployment, offshoring and globalization). The trend between 2003-2007 was one big head fake because of loosening of credit and not because of rising incomes or a higher number of jobs than the previous recovery. There was simply no there there. Given peak private employment in the United States was in the late 1990s, there can be no denial that there never has been a recovery since then.

  14. Brad says:

    ECRI–
    I follow our website weekly (sometimes daily), I have read your book, watch your interviews. I am truly sorry that you have had to expend such effort defending yourself (even your ETHICS???!!!!) from dimwitted so called experts.

    Keep up the GREAT work!

  15. Molesworth says:

    Ditto Brad

    Brad Says:
    August 31st, 2010 at 12:01 pm
    ECRI–
    I follow our website weekly (sometimes daily), I have read your book, watch your interviews. I am truly sorry that you have had to expend such effort defending yourself (even your ETHICS???!!!!) from dimwitted so called experts.

    Keep up the GREAT work!

  16. KJMClark says:

    “Because our research group is keenly aware of these issues, we have always eschewed a model-oriented optimization-based approach to business cycle forecasting.” What do they use instead, a Ouija board?

    So the ECRI isn’t based on a model, but we’re supposed to believe that it works. That’s some GREAT marketing! Geez, I thought they were using a model with a *claimed* good track record. Can’t see any reason to pay any attention to them if they don’t even have a model.

  17. mad97123 says:

    ECRI Says

    “This is an index that’s been around for over a quarter of a century, and over that time (shown here) it has correctly predicted every recession and recovery in real-time. I need to repeat that, over this entire time period, I was present to see each of the correct recession and recoveries calls in real-time, without false signals in between… Please note the WLI peaked in June 2007, six months before the recession began.”

    So the index “makes the call” in real time, not the ECRI? What is a reader to make of the statement, “I need to repeat that, over this entire time period, I was present to see each of the correct recession and recoveries calls in real-time, without false signals in between”? They need to repeat that they saw the calls “in real-time”? Sure sounds like they we’re trying to equate the ECRI with the WLI and take credit for the call themselves. While I agree this does clarify their position a bit, it still leaves room for Mish’s charge that they misrepresent the WLI calls for their own.

  18. freber says:

    It’s clear to me that you are implying that you called the recession at the same time that the WLI indicated it, hence you’re reference to “I was present”!!!!!

    This infers that you were there seeing the same thing as the WLI and knew what you were looking at.

    After all, we all were “Present” when it happened. “Present” infers on the same page, in the know, not just in the same city.

    Get real.

  19. 4horsemen says:

    ECRI:

    First, very good article. I was certainly critical of some of your comments the way they had been framed by other bloggers. You have done a good job defending your process. The evidence cited about the blogger’s self-confirming bias was particularly damning (although admittedly I often do the same thing).

    Having said that, I can not agree with everything you said. I feel it it necessary to comment on where I believe you cross the line.

    Specifically, you seem to portray yourselves as objective and process-driven in coming to your conclusions, making the results logical, non-extrapolating trajectories. For example, you write:

    “…intended only to forecast the timing of turning points and not the size of the forthcoming downswing or upswing, nor to be a general indicator of the economy”

    and…

    “Keenly aware of the limitations of our tools, we focus on turning point forecasts – not magnitude forecasts … This is also why we avoid advocating or decrying any specific policy measure, except rarely, in the narrow context of policy timing.”

    and finally…

    “That’s why we don’t belong to any particular “camp,” accusations notwithstanding. When our objective leading indexes change cyclical direction, we change our view about the economy’s direction, period. As a result, we find ourselves being alternately feted and reviled by liberals and conservatives, bulls and bears, while we stick to our knitting.”

    As much as this comes across as objective and non-denominational, it appears that this may not always be the case. Your slides above make statements like “if (the self-reinforcing downturn is) allowed to continue…” and you talk about “a recession of choice” and that policy makers did “too little, too late.” All of these statements highlight an inherent bias to a particular camp. In fact, they all imply very much that you advocate a pro-government intervention, Keynesian approach. Meddle in markets to cure the threat of recession.

    What shocked me more was that you went on to quote Hayek, who would seemingly be the last to advocate such economic meddling. In fact, he might have said that your conclusion “this decade will see more frequent recessions … result(ing) from the convergence of higher cyclical volatility and lower trend growth during expansions” would be the consequence of continuous government meddling in normal economic cycles.

    I agree, cycles will be more frequent (and likely worse each time) until we stop advocating this goddamn kick-the-can approach and let the system find equilibrium.

  20. IdiotInvestor2 says:

    ECRI :

    I follow Mish’s blog closely and agree with his economic views most of the time, but certainly not all and definitely not everything else he writes. But he provides great insight and logical arguments.

    I can understand your need to defend your business integrity and I applaud you for presenting your case.

    But from a point of view of a bystander (and an investor) this is noting but just a big debate of who said what and what time and how true it is etc. – and it is simply not valuable.

    We know where Mish stands on his economic views. He will be proven right or wrong in coming months. Whether I like his views or agree by it or not, I KNOW what his views are and they are timely.

    Where do you stand ? That’s the real question. I don’t care (and I suspect many of us) about how wrongly you were accused. But do you see a recession ? Do you think we are in a recession ? Where is economy headed ? Maybe even a bit of viewpoint about the stock market. If you have a view please share it,if you don’t have a clear idea, state it so. Noting wrong in being uncertain.

    But without presenting a concrete viewpoint this is just a fist-fight we all will tune out of.

  21. Brad says:

    A string of comments here suggest that readers didn’t read the article, or they’re dimwitted as I noted in my original comment. I may just be barking at the moon, but here goes:

    powersjq Says: “This is just long-winded nitpicking. The WLI seems to be indicating a recession, but ECRI hasn’t yet called one. That was the original question.”

    Actually, no that wasn’t the question. You should re-read this paragraph:

    “But our approach is also inconsistent with recently popular notions – once again based on conventional back-fitting of data – that, somehow, when the WLI growth rate hits a specific negative number, a recession always follows. Firstly, it’s the WLI itself, not its growth rate (i.e., its speed of descent), that’s designed to predict economic recession and recovery. Secondly, historical data going back six decades shows that the nice round number of minus 10% doesn’t work too well anyway as a recession signal. But, most importantly – regardless of unfounded accusations that we’ve “abandoned” our own indexes just because we distance ourselves from these simplistic data-mining exercises – the whole idea is fundamentally flawed. In other words, it’s a bit naïve to believe that some variety of data fitting based on conventional statistics using the WLI will tell you how to predict recession and recovery – especially if, as our critics never tire of asserting, it’s different this time.”

    KJMClark Says: “So the ECRI isn’t based on a model, but we’re supposed to believe that it works.”

    That is right. Or at least that’s why I think they quoted Friedrich von Hayek’s Nobel lecture quote:

    “It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the ‘scientistic’ attitude – an attitude which, as I defined it some thirty years ago, ‘is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.’”

    mad97123 Says: “So the index “makes the call” in real time, not the ECRI?
    freber Says: “It’s clear to me that you are implying that you called the recession at the same time that the WLI indicated it, hence you’re reference to “I was present”!!!!!”

    Did you really read what they wrote about this, or did you stop when there was the risk of learning something? To review, they wrote:

    “That slide shows our Weekly Leading Index (WLI) and includes an ECRI discussion note for the presentation saying that the WLI has been around for over a quarter century and that “it has correctly predicted every recession and recovery in real-time.”

    In fact, that statement is undeniably true. The WLI peaked and went into a cyclical downturn six months before the recession began. So this is hardly a smoking gun.”
    Okay, so far so good???

    “In evaluating the performance of any leading indicator, the key question is whether its cyclical turn occurred before the cyclical turn in the economy. If so, the follow-on question is whether that lead occurred in real time, or showed up only in revised data. In the case in question the WLI peak occurred well before the business cycle peak, in real time. That was the point of that slide.

    In this context, “being present” supports the notion that the WLI turned down in real-time, well before the recession. I think this is clear. You’d have a better point; if this next paragraph didn’t exist:
    “But, nowhere on the slide in question does ECRI claim to have predicted the recession. Nowhere do we equate ECRI to the WLI. To the contrary, a few slides later, we say that ECRI called the recession in March 2008. It’s inconceivable that anyone attending the actual presentation, or reviewing the presentation in retrospect, could come away believing otherwise.”

  22. mad97123 says:

    Brad ,

    You apparently didn’t read what mad97123 and freber actually wrote.

    It’s the ‘I’ need to repeat, ‘I’ was present that makes it sound like ECRI is trying to equate themselves to the WLI after the fact. That is what they accuse other of doing in the first part of the article if you read the whole thing yourself.

  23. Mark S says:

    Ok Lakshman and Anirvan, I really like your work, in fact I look at it all the time and wait for its release every Friday morning. It’s good stuff. But, I’m not sure what the point of the accuracy versus the we predicted or didn’t predict pissing match is all about.

    It seems that the ECRI indicatores are pretty powerful indicators of economic activity. I don’t get why everyone gets all wrapped around the axel about calling a recession anyway…

  24. powersjq says:

    @ Brad: I stand guilty as charged. I didn’t read the article closely. I skimmed it, looking primarily for tone and argumentative structure.

    Tone = wounded, whiny, and punctilious. (And Bard, your use of the ad hominem “dimwit” is even more defensive.) “We’ve never had our professional integrity called into question, until now.” ECRI publishes a politically important economic indicator and thinks that it’s work and status aren’t going to get mud on them occasionally? Or, “Our detractor’s declaration is based on a cherry-picked quote,” to wit: “[The WLI] has correctly predicted every recession and recovery in real-time”; however, ECRI goes on “nowhere on the slide in question does ECRI claim to have predicted the recession.” You’re just kidding, right? Every recession and recovery… except this one. ECRI’s tone suggests that it feels under pressure, which suggests that it feels guilty. I’m not saying it’s guilty of anything, but broadcasting one’s feeling of being embattled gives an impression of weakness.

    Structure= retreat into the technical details. ECRI understands its indicator better than anyone, which means that in talking about the specs of the indicator it has not only retreated to its most secure bastion of authority (surely a defensive move), it has also surrendered all pretense of general relevance. It was my understanding that the question was always just how relevant an indicator the WLI is. It doesn’t seem to me, however, that this piece treats that question in a succinct and clear way.

  25. lakshman says:

    4horsemen,

    Thank you for reading our article thoroughly, and for your comments.

    You raise specific issue with our views that “if (the self-reinforcing downturn is) allowed to continue…” a recession would result, and also with our assertion that this was “a recession of choice” that policy makers did “too little, too late” to avert.

    First, we presume that you also read the two articles supporting these statements that we linked to in this footnote: “On Jan. 25, 2008 we publicly described the opportunity to forestall the recession, ‘A Window of Opportunity’ and then on Mar. 28, 2008, we described how that opportunity had been missed in ‘A Recession of Choice’.” If you haven’t had the chance, please do take a look:
    Jan ’08: http://www.businesscycle.com/news/press/1402/
    Mar ’08: http://www.businesscycle.com/news/press/1403/

    When we wrote the first article in January 2008 it was already obvious that the Administration and the Congress, at the urging of the Fed, had decided to enact the first stimulus package. The money was going to be spent anyway, but looking at our array of leading indexes we had realized that there was a very unusual situation where, for once, a QUICK fiscal jolt could push off the onset of recession for a while which would potentially be very valuable in the context of the credit crisis. We were, and remain, agnostic about the composition of the jolt, but were very clear that it needed to arrive right away, i.e., in a matter of weeks, not months. In essence, when such stimulus arrives a few weeks after a potential peak in the business cycle, under very unusual circumstances (see footnote articles) there can be an opportunity to postpone the business cycle peak and attendant job losses. But if the stimulus arrives six months after a recession begins, as it did, it has no chance, and the money is essentially wasted. Our point was solely about the TIMING of large expenditure that the powers that be had already decided upon.

    Please appreciate that this has nothing to do with Keynes’ logic. We firmly believe that there is no way you can repeal business cycles in a market economy.

    Second, you say you’re shocked at our quoting von Hayek. We did so not because we have an ideology that agrees with von Hayek – or Keynes, for that matter. However, we found his observation perhaps the most eloquent exposition of our own beliefs in that particular context. That shared viewpoint is the very reason why models don’t work for forecasting business cycle turning points.

    We understand that its easier to pigeonhole people into categories like “Keynesian” or “Austrian.” ECRI actually belongs to a different, less familiar category. We are “Monitorists,” who monitor the best cyclical indicators in order to understand just where we are in the business cycle, and our forecasts have historically offended just about every “camp” in turn. That happens because we objectively and faithfully follow our leading indexes, and let the chips fall where they may.

    As an aside, you might also be interested to know about a rare occasion when we publicly expressed an opinion about policy. On September 23, 2008, when Chairman Bernanke was pressing Congress to enact the TARP, Anirvan Banerji, writing for ECRI on RealMoney.com, made the following observation:

    “We are now hearing … from Chairman Bernanke, who said today to the Senate Banking Committee that ‘I believe if the credit markets are not functioning, that jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover.’ He is quite right that if credit markets are not functioning, jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract. I have news for Mr. Bernanke. All that will happen anyway… So if Congress is coerced into spending huge amounts of taxpayer money for this bailout, we’ll end up with further debasement of the currency but do very little to address the recession, which is already a reality. The notion that ‘the economy will just not be able to recover’ without this bailout is absurd, because in a market economy, it is the wringing out of excesses (at the cost of some considerable pain to those banks) that sets the stage for the recovery phase of the business cycle. Of course, we’ll never know, because once the bailout package is passed and the economy doesn’t show much of a rebound, we’ll be told that things would have been so much worse without the bailout.”

    And again, the next day in the same forum, he wrote: “I was just discussing the gov’t bailout plan with my partner, Lakshman Achuthan, and the big worry for taxpayers that it’s a massive giveaway to Wall Street. And his thought was, why doesn’t the gov’t simply invest using the same terms that Warren Buffett got with Goldman on Tuesday? If it’s good enough for Buffett it should be good enough for taxpayers. Similarly, the terms of the Japanese investment in Morgan Stanley should suffice. Such principles of market-led valuation can serve as a roadmap for recapitalizing the financial system while salvaging some of the public’s trust in Washington.”

    I hope my reply gives you a better sense that ECRI really does stick to its knitting with an unwavering focus on the business cycle itself.

  26. machinehead says:

    I’m more interested in where we’re heading over the next six months, as opposed to rehashes of who predicted what, when. One indicator which lacks the long history of the WPI, but is quite intriguing, is the Consumer Metrics Institute growth index. It is pulled from real-time consumer discretionary purchases made on the internet, thus avoiding the lag of government retail sales statistics.

    As this explanatory article by Doug Short notes, the quarterly moving average of the index is back near its 2008 nadir:

    http://dshort.com/articles/Consumer-Metrics-Growth-Index.html

    So I’m forecasting a return to negative GDP growth in the 3rd or 4th quarter. Whether that constitutes a ‘double dip’ will be determined by the wise men at NBER, who haven’t even opined on whether a recovery began in 2009, much less on whether it ended this year.

    In my opinion, the NBER can and should be replaced by a set of designated time series and a publicly-posted algorithm that anyone can run. Calling a recession should be no more technically complex than calling a 20% decline in the S&P a bear market.

  27. rootless cosmopolitan says:

    @4horsemen:

    I agree, cycles will be more frequent (and likely worse each time) until we stop advocating this goddamn kick-the-can approach and let the system find equilibrium.

    What does “equilibrium” mean with respect to capitalist economy? Where is this equilibrium supposed to be? How do you even know the economy would go toward an “equilibrium” state? I don’t see that there is any empirical evidence for an equilibrium in capitalism. But if this is the case your proposition what shall be done so everything will become better, is just based on pure believe not based on reality.

  28. IvoZ says:

    @ ECRI

    Sorry, but here I do not see anything that proves Mish’s statements wrong. And these are numerous regarding WLI / ECRI:

    - timing of recession / recovery calls (too late in 2007/2008; too late in 2002)
    - no false signals by the WLI (what about 1987 for example?),
    - lead time of the WLI (0 to -4 months in the last 2 recessions, timely call of recovery in 2009, too late in 2002)
    - calling the 2009 recovery a strong V one, better than in 1980s (although you claim again in THIS post you do not make calls about the magnitude -> “caught” again?)
    - and most importantly using the WLI in the presentation to claim that you issued a recession warning in November, whereas actually you had a NO recession call and claimed your methodology is better than an inveterted yield curve

    All your attempts via smoe and mirrors or creating straw men arguments to rectify the situation, make it worse and your integrity even more questionable. And you took such a long time to respond to Mish. If I were him, I would not even bother responding to such “lame excuses”.

    And finally: what is your call now? Still no recession?

  29. philmor says:

    @ IvoZ

    You are a simpleton, or you are up to no good.

    Your allegation of “too late” makes no sense — or did you not read the whole part they wrote about returns and their recession/recovery calls?

    And a “strong V’ recovery is not what they said — look at the presentation for God’s sake! See slide 22 where in August 2009 they say “the early stage of this recovery would be the strongest since the 1980s.”

    Of course, the whole idea that they use more than one leading index seems too much for you to handle.

  30. MP32 says:

    Why won’t the ECRI people reveal the composition of their index? And charge for the index? What esoteric weekly info do they have that others don’t? They are free to do what they want, but not to call it scientifically respectable.

    ~~~

    BR: For the same reason you insist on getting paid when you go to work.

    Likely due to it being a proprietary work product.

  31. 4horsemen says:

    lakshman –

    Thank you for clarifying. That does help.

  32. IvoZ says:

    @ philmor

    Please spare me the ad hominem attack.

    I tried to condense what I read from Mish’s criticism (if you follow the links in the post), which seems more convincing to me so far than the half-hearted response so far. See quote and links below:

    “Furthermore, the recovery will be “V-shaped” and is now “virtually unstoppable” – at least through the first half of 2010 — Achuthan says, citing a “positive contagion” in the economy right now, based on leading economic indicators. Most notably, the ECRI’s index of Weekly Economic Indicators just hit a new record high. ”

    http://finance.yahoo.com/tech-ticker/article/351329/It

    http://globaleconomicanalysis.blogspot.com/2009/10/look-at-ecris-recession-predicting.html

  33. rootless cosmopolitan says:

    This is an index that’s been around for over a quarter of a century, and over that time (shown here) it has correctly predicted every recession and recovery in real-time…Please note the WLI peaked in June 2007, six months before the recession began.

    A correct “prediction” every time w/o “false signal”, or Texas sharpshooter fallacy from hindsight? It’s true, the turning point of the WLI was June 2007 before the recession. But there seems to be a confusion here between knowledge about this turning point in hindsight and a “prediction”. The WLI doesn’t predict anything, if recognizing this turning point as such a one ahead of a recession has the pre-condition that there was knowledge about the course of the WLI in the future. It’s like with the stock market. After a turning point, with hindsight 20/20, every one knows where the market peaked or bottomed, but it’s extremely difficult to recognize the turning point at the moment when it’s there or shortly after, and that it’s not just another wobble.