No Sight of Next Recession: Business Cycle Index Update 1/18/2018
Is your investment strategy protecting your assets from the next recession? Our Business Cycle Index is a tool to help you gauge recession risk.
Back testing the BCI (short for Business Cycle Index) shows that it would have provided, on average, a 20-week leading signal for the past seven recessions.
The BCI at 240.5 is above last week’s downward revised 240.2, and it is at a new high for this business cycle as indicated by the BCIp at 100. Also, the 6-month smoothed annualized growth BCIg is at 18.7, which is above last week’s 17.6. Both BCIp and BCIg are far away from signaling the next recession.
Figure 1 plots BCIp, BCI, BCIg, the S&P500, and the thresholds (red lines) that need to be crossed from above to below to signal a looming recession.
The Business Cycle Index
Nobody can predict the arrival date of the next recession. However, using freely available economic data we derive a reliable signal that warns of an oncoming recession. We designed the Business Cycle Index to signal well in advance the beginning of a NBER-recession. The BCI uses the below listed economic data, downloaded from FRED.
- 10-year treasury yield (daily)
- 3-month treasury bill yield (daily)
- S&P500 (daily)
- Continues Claims Seasonally Adjusted (weekly)
- All Employees: Total Private Industries (monthly)
- New houses for sale (monthly)
- New houses sold (monthly)
The 6-month smoothed annualized growth rate of a series is a well-established method to extract an indicator from it. We use this method to obtain BCIg, i.e. the calculated growth rate with 6.0 added to it. The BCIg generates on past performance an average 11-week leading recession signal when it falls below zero.
Also, the index BCI retreats from its cyclic peak before a recession in a well-defined manner. This is the basis for the alternative indicator BCIp (and its variant BCIw) which gives an average 20-week leading signal to the next recession when BCIp falls below 25.
A more detailed description of the BCI can be found here.
As a guide on how to use the BCI refer to Exit Signals for the Stock Market from iM’s Business Cycle Index and to Table 1 in this post.
Figure 2 graphs the history of BCI, BCIg, and the LOG(S&P500) since July 1967, and Figure 3 plots the history of BCIp. Overall 46 years of history that includes the seven last recessions each of which the BCIg, and BCIp, managed to signal. These graphics also include the weeks lead signaled to the then next recession.
The Unemployment Rate is Not Signaling a Recession: Update January 5, 2018
A reliable source for recession forecasting is the unemployment rate, which can provide signals for the beginnings and ends of recessions. The unemployment rate model (article link), updated with the October figure of 4.1%, does not signal a recession now.
The model relies on four indicators to signal recessions:
- The short 12-period and a long 60-period exponential moving average (EMA) of the unemployment rate (UER),
- The 8-month smoothed annualized growth rate of the UER (UERg).
- The 19-week rate of change of the UER.
The criteria for the model to signal the start of recessions are given in the original article and repeated in the Appendix.
Referring to the chart below, and looking at the end portion of it, one can see that none of the conditions for a recession start are currently present.
- The UER was in a process of forming a trough, the short EMA remains below its long EMA – the blue and red graphs, respectively, the spread is minus 0.26% (last month minus 0.28%).
- UERg has formed a trough in 2015 and is steepening, but still at a low level of minus 13.97% ( last month 13.56) – the green graph.
- Also the 19-week rate of change of the UER is now at minus 6.7% (last month minus 4.8%), well below the critical level of plus 8% – the black graph.
For a recession signal, the short EMA of the UER would have to form a trough and then cross its long EMA to the upside. Alternatively, the UERg graph would have to turn upwards and rise above zero, or the 19-week rate of change of the UER would have to be above 8%. Currently the trajectories of the unemployment rate’s short- and long EMA are still downwards – none having a positive slope, UERg is far below zero, and the 19-week rate of change of the UER is also way below the critical level.
Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon.
The model signals the start of a recession when any one of the following three conditions occurs:
- The short exponential moving average (EMA) of the unemployment rate (UER) rises and crosses the long EMA to the upside, and the difference between the two EMAs is at least 0.07.
- The unemployment rate growth rate (UERg) rises above zero, while the long EMA of the unemployment rate has a positive slope, and the difference between the long EMA at that time and the long EMA 10 weeks before is greater than 0.025.
- The 19-week rate of change of the UER is greater than 8.0%, while simultaneously the long EMA of the UER has a positive slope and the difference between the long EMA at the time and the long EMA 10 weeks earlier is greater than 0.015.
iM’s COMP: Update – January 19, 2018
COMP is a recession indicator derived from the composite data of three freely available U.S. economic indices, hence its name COMP. (See appendix A of this article for the indices and their components.) The indicator was constructed from 1968 onwards over a period which included seven recessions. COMP oscillates about zero; when it moves below zero it identifies recession periods.