US leading indicators signal recession

For various reasons, I haven't calculated my US cyclical indices for a year or more.   But I've finally updated my US data banks and psyched myself up to do the calculations, so, here goes.

The chart below shows the year-on-year percentage change in my US coinciding and my US leading indices.  They are calculated from many underlying time series and are designed to remove some of the noise caused by the plethora of indicators which move in different directions each month, and that way to give clarity about the direction of the economy.

I have plotted my leading index with a 12-month lag.  This gives us an implicit forecast of the economy's direction over the next 12 months.  Observe how covid screwed up the lags, which is logical, because the covid crash and the recovery from covid were caused by exogenous influences, not by movements in the economy itself.

Note how the percentage change in my leading index is falling fast, suggesting that over the next 6-12 months the economy will be weak, or in recession.

The chart below compares my US coinciding index with my US diffusion index.  A diffusion index measures what percentage of a universe of monitored time series is rising.  In this case, the universe is 57 different time series, almost exclusively monthly.  When all are rising, the economy is strong.  When all are falling, it's in deep recession.  It's been smoothed using a 12-month centred moving average to iron out the monthly ebbs and flows.

It leads the cycle by about 5 months.  The unsmoothed diffusion index ticked up in November, but (a) that's based only on those data which were available, and (b) small blips in diffusion indices can be revised away as more data become available, and (c) it's just one month.  However, if this is the low for the diffusion index, it nevertheless indicates that, for at least the next 5 or 6 months, the US economy will be slowing.  

None of these indices gives pin-point timing or extent of the swings in the business cycle.  However, they do give strong rough indications of what's happening.  

My guess is that the US economy will be weak or even declining until the middle of next year.   But as I have said before, this is the first recession in my long professional experience caused by the extreme incompetence of the party and politicians in office, and by damaging policies, rather than by the strong ebbs and flows of the economy, so who knows?

More than 50% of world PMI indices are now rising

 These two apparently similar charts show different things.  

The first shows my world manufacturing PMI index (green) with a diffusion index of the 53 component countries' PMIs (orange).  A diffusion index measures how many of the selected time series are rising, and how many falling.  At 0, all are falling, at 100, all are rising, and at 50 --- well you get the picture.

What this chart shows is that 70% of the PMIs I monitor are rising.     It doesn't mean that they are above the 50% recession line.  For example, Austria's PMI has risen from 38.8 in July to 43 in February.  So Austria's economy is still deteriorating, just more slowly.  A diffusion index tends to lead the underlying data, as you can see in the chart.  The rising diffusion index suggests that the PMI will keep on rising, for now, which means it will soon cross the 50% "recession line".

This chart shows the percentage of monitored PMIs which are above 50%.  Note that this coincides with my world PMI index.  More than half the countries I monitor have PMIs below 50%, which means that more than half still have weakening economies, even if they're declining more slowly.

For non-initiates, this can be a bit confusing.  After all, the PMI indices (and most business confidence indices) are themselves diffusion indices!  So, jumping to the conclusions:

• PMI surveys tend to lead the economic cycle.
• when they rise above 50%, they show that their economy is growing
• the majority of PMI indices are rising, and the trends shown in chart 1 suggest that will continue
• but the majority of PMIs are also still below the 50% "recession line", showing that the world economy is not yet accelerating.

Brazil enters recession

 As part of my goal of understanding what's happening in the global economy, I've added a deeper analysis of the smaller members of the "Big 8"  (USA, Euro zone, China, Russia, Japan, UK, India and Brazil).  I've already reported on the Russian economy.  Now it's Brazil's turn.

The chart below shows my diffusion index for Brazil compared with Brazil GDP.  As GDP is monthly, it's available more quickly than GDP data.  A diffusion index measures the percentage of monitored time series which are falling or rising.  At 50%, half the series are rising, half falling, and that normally coincides with a cyclical turning point.  A diffusion index tends to lead the cycle, since it has to turn down from its peak before it reaches the 50% recession line, and turn up from the trough before it reaches 50% from below.  My Brazil diffusion index leads by a couple of months at the trough (though sometimes it's longer) and by a couple of quarters at the top (though sometimes it's less).  A diffusion index isn't perfect, because it also picks up small and shallow cycles, which have much less economic significance.  Still, at the moment, only about 30% of time series including in the diffusion index analysis are going up.

This is still a WIP (work in progress)---I don't yet have as much data as I'd like.  But I'm working on it.  I'm also creating a coinciding index and (maybe!) a leading index.  I'll keep you posted.

World diffusion index doesn't confirm recession

 Whereas my calculation of the Big 8 PMI will prolly cross the 50% "recession line" this month, my world diffusion index is still above 50%, though it is sliding.   The PMI data are more up to date, but the diffusion index covers far more time series.  The longer-term correlation between the two is close.  We might not in fact enter a recession until Q1 2023, though I have been forecasting it to occur in Q4 2022.  We shall see.

Commodity prices to fall further

 It's obvious that commodity prices, as measured by the CRB index, have peaked.  Commodity prices follow the world growth rate, though of course there are obviously other factors, such as war, droughts or boycotts, which help nudge prices higher at times.  

The chart below shows my world diffusion index, which measures the percentage of monitored times series rising.   At zero, all series are falling, at 50% half are rising, and at 100% all are rising.  My world diffusion index monitors up to 303 time series, covering a wide range of different activities for most countries in the world.  It is not weighted by country GDP, unlike, for example, my calculation of the Big 8 PMI or industrial production.   

In my judgement, world economic activity is going to continue to slow, and so world commodity prices on average will too.  "On average" is a key qualification.  Some commodities, such as lithium, are still rising.  But oil and gas are falling, despite supply constraints, though the declines are not yet precipitous.

My US diffusion index continues to slide

 A diffusion index measures the percentage of time series one is monitoring which are rising or falling.  If a time series is rising, it scores 1, if it is flat, it scores 0.5, and if it is falling it scores 0.  The scores are then added up, and the result divided by the number of indicators available for that month.  It tends to lead the business cycle, because when 100% of all monitored series are rising, the economy is strong.  Gradually, one by one, indicators stop rising, usually well before the overall diffusion index reaches 50%, which marks the flexion point in the economic cycle.  In the same way, at the bottom of the cycle, one by one series turn up, until half the measured series are rising.  Because of this, a diffusion index tends to be a good leading indicator of the overall economy.

My US diffusion index is paired with my shorter-leading US index in the chart below.   The diffusion index is already below 50%, which would suggest that the economy is already in recession.  This seems doubtful to me -- current data suggest that the US economy is still advancing, just.  But it should go into recession next month (November) or the month after. 

Notice how the diffusion index had turned up before the covid crash hit, then rose sharply as it waned, in response to fiscal and monetary stimulus, and how it has been falling (even as the economy kept going) since late 2020.  

World industrial production slowing

 My calculation of world industrial production (data through May 22) is plotted (extreme adjusted, to reduce the covid spike in 2020) as a percentage of its long-term moving trend, compared with a diffusion index of all its components.  The diffusion index, which measures the percentage of the time series in the sample space which are rising, tends to lead the actual industrial production index, especially at cyclical peaks.   A majority of the monitored series are still rising, but a smaller percentage than earlier this year.  Just because the diffusion index is falling does not mean that the world will enter a recession.  Previous decelerations have been associated only with temporary slow-downs.  However, its decline is consistent with the other indications that we will experience a global recession.

World Industrial production

Well, after an absence of over 2 years, here are the latest data for my world industrial production index.  In my last post, back in 2020, I turned out to be quite wrong about how rapidly the world economy would recover from the COVID crash.  It turned out that world governments and Central Banks responded with the massive stimulus and interest rate cuts, which stimulated a rapid rebound from the crash lows.

I also calculate a diffusion index of all the world industrial production indices.  A diffusion index measures how many of the observed time series are rising.  At the depth of a recession, few are.  At the peak of the cycle, most are.  At 50%, half the components are rising, and half are falling.  

If the diffusion index is rising, this suggests that the overall universe measured by the diffusion index is accelerating.   

The chart below shows the level, not the rate of change, of the index of world industrial production, compared with the diffusion index of all the component production indices.  Note the deep slump caused by Covid.  In the recovery from Covid, 97% of the measured industrial production indices were rising.  This fell to 60% as the rebound faded.  But recently, the number of industrial production indices rising has gone back to 80% of the total, suggesting growth is picking up.  This impression is confirmed by shorter rates of change.  If you look at the 6-month change in world IP, at annual rates, for example, it's moved from ± 0% in September 2021 to ±8% in March.   This is interesting because other data (PMIs, for example) suggested that though growth was still strong, it was slowing.  

It takes around a year for interest rates increases to cause economic indicators to start growing more slowly.  The average Central Bank discount rate has been rising since December 2020, though from exceptional lows.  So we would have expected the world economy to start slowing by now.  On the other hand, the Fed only started raising the Fed Funds rate in March.  The US is the world's largest economy.  So we may have to wait for the US to start slowing before we see declines in world aggregates.  

We'll see.

Momentum in US econ drifting lower

 The two manufacturing PMIs for pan-US activity showed opposite signs in April, the IHS Market one strengthening, the Institute of Supply Management (ISM) one falling.  As usual, my recommendation is to watch the average of the two ― the green line in the chart below.  Reminder:  any data point above 50 still shows an expanding economy, but a fall in the PMI shows that it is expanding more slowly.  But, at current levels, these indicators are still at or above previous cyclical highs.  Which shows that the economic is still expanding fast.