Prieur du Plessis is the author of the Investment Postcards blog - subscribe here.
The latest smoothed annualized growth rate of the ECRI Weekly Leading Indicator of 1.8% published last week marked the 11th week of moderation since its recent high of 7.7% in April. The decline was in line with the marginal changes in the growth in most of the variables that I use and which seem to explain the growth in the ECRI WLI fairly accurately. (Please note that I do not have knowledge of the proprietary ECRI WLI constituents and simulate the Index based purely on my own research.)
The smoothed annualized growth rate of the S&P 500 over the same period declined slightly from 12.3% to 11.8%, while the decline in the growth rate of the 10-year bond yield eased slightly from -5.4% to -4.7%. The Economist Metals Index’s growth rate improved slightly from 10.07% to 10.11% and the smoothed annualized growth rate of initial jobless claims declined from -3.0% to -4.0%.
By closing at 1344 last week the S&P 500‘s growth rate moderated further to 11.4% from 11.8%.
Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.
The closing yield of 3.05% on the 10-year bond index meant that the growth rate fell to -4.8% compared to the previous week’s -4.7% and points to contraction.
Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.
My estimate for last week’s closing level of the Economist Metals Index also points to a further moderation in growth from 10.1% to 9.7%.
Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.
If I assume that initial jobless claims remained unchanged at the previous week’s 418000 the smoothed annualized growth rate of initial jobless claims has increased slightly from -4.0% to -3.9%.
Sources: Dismal Scientist; I-Net Bridge; Plexus Asset Management.
On balance, I therefore expect last week’s smoothed annualized growth rate of the ECRI WLI (to be published on Friday) to come in at approximately 1.6%, slightly down from the previous week’s 1.8%.
Economy - The Longer-Term Outlook
It is clear that the smoothed annualized growth rate of the WLI is on a knife edge. A drop below zero will get the bears rolling again, calling for a recession next year. Yes, just as they did in the middle of last year when they were terribly wrong. OK, the market was saved by QE2!
Sources: Dismal Scientist; Plexus Asset Management.
But will the growth of the WLI turn negative?
To me the S&P 500 is the most important factor in determining where the growth rate of the ECRI WLI is heading. To get a feel of what is about to happen to the WLI growth rate I factored three scenarios into my model. One is where the S&P 500 remains unchanged in the next eight weeks and the other two are 5% up and 5% down respectively.
Well, did you expect this week could mark the make or break of the growth trend in the ECRI WLI?
Sources: Dismal Scientist; Plexus Asset Management.
If the S&P 500 Index closes this week unchanged at 1343 its smoothed annualized growth rate will increase to 11.8% from last week’s 11.4%. A stable market will ensure the growth rate accelerating to more than 15% over the next four weeks. If the market gains 5% this week and stabilizes thereafter, the growth rate will accelerate to more than 23% over the next five weeks. If the market closes the week 5% lower and then stabilizes, the growth rate will continue to fall in coming weeks.
The same growth trends are evident if the same scenarios are applied to the Economist Metals Index.
Metals Historical and Unchanged
Sources: Dismal Scientist; Plexus Asset Management.
If I apply three scenarios to the yield on the 10-year government note where the rate closes unchanged for the week or 15 basis points higher or lower and remains constant in the ensuing weeks, a pattern similar to that of the S&P 500 and the Economist Metals Index emerges.
Sources: Dismal Scientist; Plexus Asset Management.
So yes, a clear make-or-break situation. Last week’s smoothed annualized growth rate of the ECRI WLI (published on Friday, July 15) could herald the bottom of the downtrend in the growth rate unless the S&P 500, metal prices and bond yields fall in the week ahead. My bets are on the downtrend bottoming.
