ECRI chief sees no sign of US recession

Says indices show India healthier than America currently

New York-based Economic Cycle Research Institute has had an extended record of correctly predicting cyclical turning points in growth and inflation of economies.

The institute, started by Geoffrey Moore, once Alan Greenspan’s statistics professor, doesn’t proffer point forecasts such as 8.3% GDP growth expected in the first quarter, etc.

Instead, it tells when a cyclical turn will occur in an economy using what it calls are “reliable sequences of events”..

Lakshman Achuthan, managing director of the institute, told Raj Nambisan and Vivek Kaul in an email interview why, at the current stage of US economic cycle, major stock market corrections tend to be rare, and do not send important economic signals.

Are business and stock market cycles intertwined at all points in time? Is there a case for one leading the other? How does the relationship work?

Generally, yes. This is because stock prices are related to profits growth (which depends on the pace of economic activity) and interest rates (also dependent on economic growth). Stock prices usually have a short lead of a quarter or two over the economy, but they can give false signals so it is better to use a well constructed leading index instead for forecasting the cycle.

You have said in a recent report that sizeable stock price declines are probably not imminent, but even if they do occur, are unlikely to have important economic implications. Is this true even in the context of emerging markets like India?

No. The study we have done is for the US market specifically, but the general theory does hold for India too. Our Indian Leading Index is actually much healthier than the US. So that is in fact supportive of corporate profits, and therefore stock prices.

Stock markets have always been an indicator of where the economy is heading. What makes you say, that there is no longer a connect between stock markets and economic cycles. Would that be true in the case of India as well?

There is a connection between stock prices and economic cycles. Stocks are a “short-leader” of the economy. Our leading indexes look at other, unrelated leading indicators of the economy, some of them with longer leads than stock prices.

It is on the basis of these leading indexes that we gauge the “risk” associated with stocks, and this does hold for India.

Is the current Sensex correction of 1900 points in a week in India a harbinger of things to come?

This seems to be something more technical and having to do with a regulation as opposed to a harbinger of slower economic growth ahead. As indicated, Indian economic growth looks to improve over coming quarters.

You’ve said that corrections tend to be nastier when the ECRI leading indices point to slowing growth. You haven’t flagged a US recession yet. Still, do you see growth slowing with the subprime issue yet to fully pan out

Yes, US growth is slated to have a broadbased slowdown affecting all major sectors of the economy (services, manufacturing and construction).

However, growth is slowing from 3.8% growth in Q2, and roughly 3% growth in Q3 (we get the data on October 31) so there is room to slow without recession. The credit crisis is part of the reason for the slowing.

In the last two months, Alan Greenspan, former Federal Reserve chief, has reduced the odds of a US recession from one-third chance to one-half now.

ECRI hasn’t given its verdict yet. Is there a perceptible decrease in your estimates of a US recession in the last 2-3 months?

Over the past year, the consensus recession probability estimate has hovered around 25%, but it jumped this summer to somewhere between a third and a half.

In truth, a 50-50 probability of recession implies that a forecaster is clueless about whether or not a recession is likely, and a coin flip would be just as accurate. Edging the recession probability down closer to one-third is not much better.

While the recession probability is never zero, ECRI’s indicators suggest that the recession risk today is much lower than the consensus believes.

ECRI’s recession forecasts have always been based on objective leading indexes, rather than on plausible parallels with the past bolstered by gut feel and selective statistics.

Based on that time-tested approach, we do not see a recession at hand. When recession risks actually rise, that should show up first in our leading indexes.

Will the ARM mortgage resets that intensify from November aggravate the subprime crisis, and therefore increase the chances of a US recession?

Perhaps, but if so our leading indexes will pick that up. It is notable that Libor rates have declined since the Fed rate cut so the resets are not as bad as they were in late August.

Is there a timeline where, based on the ECRI leading indices, you can presage the weakest or most volatile period in the short-term for the Dow?

Yes, if and when our leading indexes signal a recession (they do not say that today).

Most major bear markets are associated with recessions.