Monday, November 2, 2015

Forecasting the 2016 election economy, first forecast: the long leading indicators

 - by New Deal democrat

Last week I showed that, going back 160 years, roughly 3/4 of all US Presidential election results correlated positively with whether or not at the time of the election campaign, the US was in a recession or not. More than 2/3 of the time, it accurately predicted the Electoral College winner, and 80% of the time, it accurately showed the winner of the populat vote.  In fact, if we simply go by the metric of whether or not the US was in recession during the 3rd Quarter of the election year, then 84% of the time the winner of the popular vote was from the incumbent party if the economy was expanding, and from the opposition party if the economy was in recession.

We now have enough information to make a good forecast as to whether or not the US economy will be in recession in Q3 2016.  That means we can make a reasonable forecast as to which party's candidate will win the popular vote.

Prof. Geoffrey Moore, who for decades published the Index of Leading Indicators, and founded the Economic Cycle Research Institute (ECRI) in 1993, wrote  Leading Economic Indicators: New Approaches and Forecasting Records describing and explaining what he called "long leading indicators," that is, economic metrics that reliably turn a year or more before the onset of a recession.  He identified 4:

- corporate bond yields
- housing permits and starts
- real money supply
- corporate profits

A variation of the above is Paul Kasriel's "foolproof recession indicator," which combines real money supply with the yield curve, i.e., the difference in the interest rate between short and long term treasury bonds. This turns negative a year or more before the next recession about half of the time.

Another long leading indicator has been described by UCLA Prof. Edward E. Leamer who has written that "Housing IS the Business Cycle."  In that article he identified real residential investments as a share of GDP as an indicator that typically turns at least 5 quarters before the onset of a recession.

Finally, Doug Short has identified real retail sales per capita as another important metric.  This metric tops out at least a year before the onset of a recession about half of the time.

That gives us a total of 7 long leading indicators.  All of these economic series have a long term history of turning a year or more before a recession.  Let's look at them in turn:


With the sole exception of the 1981 "double-dip," corporate bond yields have always made their most recent low over 1 year before the onset of the next recession.  Corporate bonds most recently made a confirmed low 3 years ago. BAA-rated corporate bonds equalled that low, but AAA-rated bonds did not:

This is a negative, but the good news is that frequently a recession has not occurred until 4 years or more after these lows.


With the exception of the 1981 "double dip" and the 1970 recession, these have always peaked at least one year before the next recession.  Both housing permits for single family structures and housing starts made new highs in the #rd quarter.  Here is the long-term view:  

And here is the last 3 years:

I am not making use of housing permits for mult-unit structures because these were distorted by the expiration of a NYC housing program at the end of June.  This caused a rush to get permits for multi-unit structures before then, pulling the number forward and depressing subsequent months.  This program did not affect single structure permits, nor did it affect housing starts. 

This is a positive.


Real money supply, whether measured by M1 or M2, continues to be positive:

In addition to the 1981 "double dip," on only 2 other occasions have these failed to turn neegative at least 1 year before a recession.  No recession has ever started without at least one of these two turning negative.


Ideally we would like corporate profits and wages to grow at about the same rate.  Unfortunately since 2000, corporate profit growth has soared while wages have stagnated.  But worse than soaring coporate profits are declining corporate profits: when profits decline businesses stop hiring and if that isn't enough they start laying people off.

Corporate profits have peaked at least one year before thennext recession 8 of the last 11 times, one of the misses being the 1981 "double-dip." The best metric for corporate profits for the 3rd Quarter won't be reported until the end of November..

  But a good proxy, Proprietors' Income, which is almost as reliable, was reported last week:

Proprietors' Income, deflated, made a new high in the 3rd Quarter.  This is a positive.


Since 1960, the yield curve inverted more than one year before the next recession about half the time. Below is a graph of the yield on a 10 year US Treasury minus the yield on a 3 month Treasury:

No recession in the last 50 years has started without an inversion in the yield curve (i.e., 3 month Treasuries yielding more interested than 10 year Treasuries).  This statement was not true for the period from 1932-1954, so I do not regard this metric as being that helpful, and Paul Kasriel himself has ntoed that the FED's Zero Interest Rate Policy moots this indicator.  Nevertheless, it is positive now.


Basically this is spending on private housing as a percentage of GDP. Aside from the 1981 "double-dip," and 1948, it has always peaked at least one year before the next recession: .  

Last Thursday it was reported for the 3rd Quarter and made a new post-recession high:

This is a positive.


This basically tells us how much spending is being done for each consumer.  Consumers tend to cut back well before the economy as a whole rolls over.  It has peaked 1 year or more before the next recession about half of the time. .  

Here is what it looks like for the last 20+ years:

This made a new post-recession high in the last month.  This is a positive.


Six of the seven long leading indicators had their most positive readings of this economic expansion in the 3rd Quarter just ended.  This gives us a good indication that the economy will not be in recession by the 3rd Quarter of next year. 

Note that none of the indicators are perfect. None of them forecast the 1981 "double-dip," which was engineered by the Volcker Fed.  If the Fed similarly decided to raise rates aggressively in the next 6 - 9 months, or if there were an Oil price spike caused by a Middle eastern War, a recession could happen anyway.

This is a very preliminary forecast, but nevertheless based on the 160-year correlation between economic expansions and Presidential election results, if there is no exogenous economic shock, the most likely winner of the 2016 Presidential election will be the Democratic nominee.