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US Business Cycle Risk Report | 19 May 2017

Summary:
Political uncertainty for the US is on the rise, but economic risk remains low. The turmoil surrounding President Donald Trump raises questions about the viability of his administration’s pro-growth policy agenda. Nonetheless, it’s debatable if the economy is vulnerable due to elevated political risk, in part because there’s no sign of macro stress based on the numbers published to date. Economic momentum for the US remains strong as the expansion nears the eight-year mark. The last recession ended in June 2009, according to the National Bureau of Economic Analysis, and the probability is low that a new downturn will start in the foreseeable future. But there may be an economic price to pay for the political chaos in Washington. The Economic Policy Uncertainty Index for the US has

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Political uncertainty for the US is on the rise, but economic risk remains low. The turmoil surrounding President Donald Trump raises questions about the viability of his administration’s pro-growth policy agenda. Nonetheless, it’s debatable if the economy is vulnerable due to elevated political risk, in part because there’s no sign of macro stress based on the numbers published to date.

Economic momentum for the US remains strong as the expansion nears the eight-year mark. The last recession ended in June 2009, according to the National Bureau of Economic Analysis, and the probability is low that a new downturn will start in the foreseeable future. But there may be an economic price to pay for the political chaos in Washington.

The Economic Policy Uncertainty Index for the US has recently spiked, highlighting the potential for blowback. The index’s creators – a trio of economists – advised in a 2016 paper that a higher reading of “policy uncertainty foreshadow declines in investment, output, and employment in the United States.” That doesn’t mean that recession risk will surge, but there is a connection in some degree between political uncertainty and economic activity.

Meantime, the probability is virtually nil that an NBER-defined recession has started, based on numbers published to date via the Capital Spectator’s proprietary business-cycle indexes. The nearly complete profile for April shows that just two of 14 indicators in our model are negative. As such, the economy’s forward momentum looks set to roll on for the near term.  (For a more comprehensive read on business-cycle analysis on a weekly basis, see The US Business Cycle Risk Report.)

US Business Cycle Risk Report | 19 May 2017

Aggregating the data in the table above continues to show that the broad trend remains positive. The Economic Trend and Momentum indices (ETI and EMI, respectively) continue to print at a moderately elevated levels, holding on to gains that unfolded in previous months. As a result, both benchmarks remain well above their respective danger zones: 50% for ETI and 0% for EMI. When/if the indexes fall below those tipping points, we’ll have clear warning signs that recession risk is at a critical level, in which case a new downturn is likely. The analysis is based on a methodology outlined in my book on monitoring the business cycle.

US Business Cycle Risk Report | 19 May 2017

Translating ETI’s historical values into recession-risk probabilities via a probit model also points to low business-cycle risk for the US through last month. Analyzing the data with this methodology indicates that the odds are close to zero that NBER will declare April as the start of a new recession.

US Business Cycle Risk Report | 19 May 2017

For perspective on looking ahead, consider how ETI may evolve as new data is published.  One way to project future values for this index is with an econometric technique known as an autoregressive integrated moving average (ARIMA) model, based on calculations via the “forecast” package for R. The ARIMA model calculates the missing data points for each indicator for each month — in this case through June 2017 (Feb. 2017 is currently the latest month with a full set of published data). Based on today’s projections, ETI is expected to remain well above its danger zone in the immediate future.

US Business Cycle Risk Report | 19 May 2017

Forecasts are always suspect, but recent projections of ETI for the near-term future have proven to be relatively reliable guesstimates vs. the full set of published numbers that followed. That’s not surprising, given ETI’s design to capture the broad trend based on multiple indicators. Predicting individual components, by contrast, is prone to far more uncertainty. The assumption here is that while any one forecast for a given indicator will likely be wrong, the errors may cancel out to some degree by aggregating a broad set of predictions. That’s a reasonable view, according to the generally accurate historical record for the ETI forecasts in recent years.

The current projections (the four black dots in the chart above) suggest that the economy will continue to expand. The chart above also includes the range of vintage ETI projections published on these pages in previous months (blue bars), which you can compare with the actual data (red dots) that followed, based on current numbers.

For additional perspective on judging the track record of the forecasts, here are the previous updates for the last three months:

19 Apr 2017
21 Mar 2017
17 Feb 2017

Note: ETI is a diffusion index (i.e., an index that tracks the proportion of components with positive values) for the 14 leading/coincident indicators listed in the table above. ETI values reflect the 3-month average of the transformation rules defined in the table. EMI measures the same set of indicators/transformation rules based on the 3-month average of the median monthly percentage change for the 14 indicators. For purposes of filling in the missing data points in recent history and projecting ETI and EMI values, the missing data points are estimated with an ARIMA model.

James Picerno
James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers. Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg Markets, Mutual Funds, Modern Maturity, Investment Advisor, Reuters, and his popular finance blog, The CapitalSpectator.

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