SocGen’s Albert Edwards was out with a note today which is in line with my calls for a marked slowing of the economy toward the end of this year. He indicates that the rate of change in leading indicators in the real economy and in markets is rolling over right now. Edwards writes that this suggests softness in six-to-nine months (hat tip Scott).
I like his analysis because it depends on first derivatives or the rate of change rather than absolute levels which are misleading at turning points (see Has the increase in U.S. jobless claims peaked? from March 2009 for an example of first derivatives presaging the end of recession). Remember, a recession begins from a cyclical peak in economic activity. So, the economy is rising until that point. Analysts looking at absolute levels only will miss the slowing in the rate of change.
I have had a few e-mails recently about some of the key leading indicators reaching new cyclical highs last week, and what this means for our view. To be sure, the latest weekly reading for the Economic Cycle Research Institute (ECRI) key lead indicator reached a 99 week high. That, at first sight, looks very bullish for the continuation of this cyclical upturn. However, as with all of these lead indicators, it is the rate of change that is important. The ECRI also report a smoothed annual change in their index. Last week that slipped to +12.5% yoy, which is a 37-week low (see chart below). Now one doesn’t want to be too armageddonish at this stage, but this is clear evidence that in 6-9 months time there will be a discernible slowdown in the economic recovery from its recent moderate pace.
The same dynamic is true for the OECD and Conference Board leading indicators as well – as it is for the change in analysts’ global EPS optimism, which is rolling over and leading the OECD indicator down.
The chart I found most compelling was the change in analyst optimism mapped against the 6-month change in the S&P. Note, we are measuring the first derivatives for analyst opinions here. So that means the rate of change is slowing even while the optimism is increasing. Notice how well the datasets have coincided over the past decade.
Bottom line: This recovery is going to stall in the second half of 2010 unless… But, Obama probably doesn’t get that. As for investors, Edwards says:
[I]f the trend is your friend until it meets a bend, that trend is now the investor’s enemy.