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This Little-Known Fed Index May Be Signaling Recession
6/25/2013 11:00:00 AM
Over the pastyear ,economists have noticed an unusual pattern as they digested the series of monthly reports on housing, consumer confidence, purchasing managers, trade flows and other key economic inputs.
These reports showed consistently mixed signals, though it was clear that the U.S.economy was faring OK. And that has led to hopes of more consistently positive reports in the second half of 2013 and into 2014. By next year, many economists have come to expect a firmer backdrop, withGDP perhaps growing in the 2.5% to 3% range.
Yet it may be time to start questioning that brightening outlook. Perhaps the greatest measure of economic activity -- one ignored by most investors, unfortunately -- is flashing yellow and may soon be flashingred .
Yet economists at the Chicago Fed emphasize the importance of looking at longer-term trends rather than monthly snapshots. That's why they suggest that the three-monthmoving average of these reports is where you should focus -- and by that score, the CFNAI is in trouble.
CFNAI 3-Month Moving Average
Though the CFNAI began the year in positive territory, it has recently slipped below negative 0.40.Note that the Chicago Fed believes that a reading of negative 0.70 signals entry into arecession , and we still have a ways to go before that happens.
In addition, the current slide could prove short-lived. After all, this index slid to negative 0.49 in October 2012 and then rebounded. Back then, the economy was looking tenuous as businesses and consumers were frozen by fears of a possible government shutdown (which never came to pass).
This time around, gauges of consumer activity appear to be holding their own, but several business gauges -- such as the purchasing managers' index,sales trends andinventory changes highlight a slowly weakening business sector.
The question is whether the ongoing challenges in Europe, the incipient slump in China, Brazil and elsewhere, and the impact of our own sequesterwill lead to further weakness in the business sector. This is anissue that you should be closely monitoring if you remain fully invested in thestock market , especially if you're holding economically sensitivestocks .
Later this week, a number of Federal Reserve members will be weighing in on the economy, including:
Earnings Season Commentary
My biggest concern: The sharp recent weakening in many currencies could lead U.S. multinational firms to trim expectations as foreign sales are denominated back into dollars. On a related note, how will recent turmoil that has emerged in China (bankingliquidity ), Turkey and Brazil (social unrest), and Greece and Italy (spikingbond yields) affect company outlooks?
Risks to Consider: As anupside risk, the CFNAI could rebound as we move past the effects of the recent government sequester.
Action to Take --> Although the Chicago Fed's National Activity Index dipped to similarly concerning levels in October before rebounding, you shouldn't dismiss this current reading. Prior to October, the last time this reading was less than negative 0.49 was back in 2008 and 2009, when the economy was on extremely tenuous ground. Though it's unlikely that we'll see as sharp an economic slump as we did back then, it's becoming harder to rule out at least a mild recession in comingquarters -- which is food for thought with the major market averages still near all-time highs.