Real Time Recession Indicator: 9.18.12
A real time recession indicator constructed from a composite of leading economic indicators, high frequency economic data, and SP500 pricing models continues to suggest that the US economy is NOT in recession.
This composite indicator utilizes data from the Economic Cycle Research Institute (WLI, LEI), the Philadelphia Federal Reserve (Aruoba-Diebold-Scotti Business Conditions Index), and the Chicago Federal Reserve (Chicago Fed National Activity Index). Furthermore, two SP500 price models (one proprietary and one not) are monitored. The data from the regional Federal Reserves and the ECRI continue to firm to the positive. In addition, the priced based models are far from confirming a recession. Although not in recession territory, growth isn’t exactly robust either as most measures are hugging the zero lines.
Figure 1 is a weekly chart of the SP500 with the composite Real Time Recession Indicator in the lower panel. With the indicator below the midline, the US economy is NOT in recession. Past and recent signals are shown. The 2011 signal turned out to be false and coincides with the launch of Operation Twist.
Figure 1. SP500/ weekly
So let’s ask a simple question: How good is the Real Time Recession Indicator? To answer that question we will construct a strategy where we buy the SP500 when the indicator is not in recession (i.e., at or below the blue line in figure 1) and we will sell that position when the indicator suggests that the US economy is in recession (i.e., above the blue line). Since 1970, such a strategy made 1905 SP500 points; over the same time, buy and hold SP500 yielded 1370 points. The largest drawdown for the strategy is about 30% versus 55% for buy and hold. This strategy would have had you in the market 67% of the time. The equity for this strategy is shown in figure 2.
Figure 2. SP500/ weekly
