The End of the Recession: A New Indicator Predicts With Startling Accuracy

by Matthew Weinschenk

The End of the Recession: A New Indicator Predicts With Startling Accuracy

by Matt Weinschenk, Senior Analyst

Tuesday, May 26, 2009: Issue #1004

What would you do if you knew exactly when the end of the recession would be?

Pour your cash back into the market? Hire a few new people at work? Or just sleep a little bit easier at night?

Every week, a government report is published that provides the only number needed to pinpoint the end of the recession. And in four of the last five recessions this number has peaked four to six weeks before the turnaround of the recession (and in the fifth, it was only two weeks late).

Don't forget, the market is always ahead of the economy - but predicting the recession's bottom four to six weeks ahead of time could be more of a profit-maker and less of a parlor trick.

It's all available in the weekly unemployment report released every Thursday by the U.S. Department of Labor.

Here's the interesting thing: For decades, investors and academics have scrutinized the unemployment figures to get an edge... but it never really seemed to be there. Unemployment rates are lagging indicators that show hiring after the economy has already picked up steam. By then, the market is already rolling at a full boil.

But they've been looking at the wrong number...

Pinpointing the End of the Recession Through Initial Jobless Claims

New research from Bob Gordon, macroeconomist and member of the NBER business Cycle Dating Committee, reveals a shockingly robust indicator - based on unemployment - which pinpoints the end of the recession.

What it's saying right now shouldn't be ignored. And there's a trick to it: Don't look at unemployment rates, look at initial jobless claims - which measures newly unemployed people filing for their first unemployment benefits.

It makes sense that this number "getting less bad" would be good. But how does it stack up as an indicator?

By comparing the four-week moving average with the official ending of the recession, you'll see a strong pattern.

Four-Week Moving Average Vs. Official Ending of the Recession

The ends of recessions were predicted four to six weeks ahead of time, for four out of five recessions. That's an impressive track record. Even the off-value, the 1991 recession, was still identified within three weeks of the recession's bottom.

After knowing that, I'm sure you're just as curious on initial jobless claims numbers right now. Take a look.

Jobless Claims Numbers Chart

New claims peaked on April 4. On Thursday, the Department of Labor reported an additional 12,000 decline in claims from the previous week.

Just because initial jobless claims have declined a bit since April, what's to say they are not going back up again? How do we know this is a true peak?

Gordon provides a wealth of evidence to suggest that this is not a false peak.

For one, the recession is already 68 weeks old. Second, past false peaks have typically come at about 81% of the eventual true peak. If that holds, we'd be looking at an eventual peak of 730,000 to 800,000 new claims per week. That's not impossible, but it's unlikely.

Working in Many Markets & Recessions

There is also the typical concern that, "this time it's different." That's why it's important to note that each of the recessions examined had very different causes and characteristics.

Now we're simplifying complex interactions in grouping these economic cycles...

  • After all, the 1973 recession was triggered by a quadrupling of oil prices,

  • The 1980s' recessions were due to tight monetary policy to curb inflation,

  • The early 1990s' recession was, in part, caused by the savings and loan financial crisis,

  • And 2001 was the collapse of the Internet bubble.

Regardless of the details, there is a clear indication that initial jobless claims can be useful for prediction across many types of recessions.

Turning An End of Recession Prediction into Money

Stepping outside of Mr. Gordon's analysis, what does this turnaround in the economy tell us about the movement of the stock market? Well, take a look at the last recessions and their S&P 500 market lows.

The Last Economic Recessions and Their Coinciding S&P 500 Market Lows

The average lead-time from bottom to recession's end is just over four months.

It's unlikely that we'll go any lower than the March 6 lows, but it doesn't mean we won't see a significant pullback from the recent rally.

And this isn't the only indicator we're seeing of increasing economic activity. The Baltic Dry Index has posted sharp gains in recent weeks.

Sharp Gains On The Baltic Dry Index

And there are indications that Los Angeles port traffic is up as well, which is a boots-on-the-ground indicator of an increase in international trade.

So what should you do today?

The Best Market Strategy For Investors

For most investors, the best strategy is to stay invested and asset-allocated at all times. There have been dozens of studies to prove this that I won't rehash here.

If you're still sitting on the sidelines and contributing to the massive cash buildup, hopefully this 'end of recession' indicator should give you enough confidence to start moving back into the markets.

You might find the market is taking off without you in the coming months if you don't...

Ahead of the tape,

Matt Weinschenk

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