Thursday, January 02, 2020

Will Recession Strike in 2020?

By Burton G. Malkiel and Atanu Saha. Excerpts:
"The Conference Board, a nonprofit for economic research, tracks 11 predictive measures of future economic activity in its Index of Leading Economic Indicators. The LEI purports to forecast the economy over the coming three to six months. The individual components include data on unemployment, the direction of the stock market, consumer and business sentiment, and manufacturing activity. Unfortunately, the LEI is somewhat unreliable as a forecaster and often misleading.

We examined the record of the LEI (and its components) over the eight recessions and nine sudden market declines of 15% or more since 1960. The good news is that the LEI and many of its components have had a near-perfect record in anticipating recessions. The most reliable indicators have been the shape of the yield curve, business and consumer confidence, durable-good purchases and housing starts, and the health of the labor market. These measures have also correctly signaled stock-market downturns. (The biggest exception is consumer spending, which has risen before nearly every past recessions, falling only after the recession starts.)

Yet despite the LEI’s fair record, there are good reasons to doubt that any economic statistic can reliably predict when a downturn will occur. Since 1958, even when the indicator was correct, the lead time between its turning negative and an economic slide has been as long as 18 months. Worse, there have been many false positives. Leading indicators have incorrectly forecast a downturn many more times than they correctly predicted recession or stock-market decline. In fact, the most accurate indicators have the highest incidence of false positive signals. A signal that often predicts recessions that don’t happen is more misleading than helpful. As the economist Paul Samuelson once quipped, “The stock market has predicted nine of the last five recessions.”

Today, the auguries are generally favorable. Stocks and the labor market have performed well, and the yield curve is sloping upward again. But business confidence has declined over the past three months through November, based on uncertainty about trade and global politics."

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