Good leading indexes are pointing to a continuation of the reflation trade. It would be wise to heed them, as they presciently flagged its onset well before the consensus caught on. A key reason we were able to have conviction in that contrarian view – laid out in our April 3 article – is that the "vicious" and "virtuous" cycles that define recession and recovery worked in textbook fashion during the Covid crisis, even with the off-the-charts policy responses.
As we explained at the time, a recession is a vicious cycle of falling output, income, employment and sales, feeding back into further declines in output, and so on. Looking at the data in the rear-view mirror makes this plain enough. Aggregate economic activity peaked in February and turned down with a vengeance, resulting in the self-feeding vicious cycle to the downside (see chart below). That’s why February is the peak of the business cycle (vertical red line) – the month when the previous expansion ended and the recession began.
Nasty, But Brief Recession
“It’s when this vicious cycle ends, and switches to a virtuous cycle of self-feeding increases in output, employment, income and sales,” we wrote in April, “that a recession is officially over.” We predicted that – with the end of the compulsory closures likely to help “jump-start this virtuous cycle in relatively short order” – the recession would be “extremely deep, very broad, but relatively brief.”
Cycles Turned Higher in April
Indeed, employment turned up in April (lower panel). In perfect lockstep, real personal income excluding transfer payments (upper panel, solid line), real consumer spending (second panel), and industrial production (third panel) all also turned up in April (vertical dashed black line).
Real manufacturing and trade sales – a more inclusive measure than consumer spending – did so too, while real GDP – a more comprehensive measure of output than industrial production – turned up around the same time, in Q2 2020 (not shown).
Sure, the multi-trillion-dollar stimulus package made total real personal income surge in April before easing off (upper panel, dashed line). But as important as it was to lower-income families in need, that one-time injection of money didn’t change the business cycle. Rather, the April upturn in earned income – real personal income excluding transfer payments – is what helped flip the recessionary vicious cycle into a self-feeding virtuous cycle.
It's the Cycles, Not the Headlines
These data illustrate the tremendous durability of standard cycle dynamics, which stand in sharp contrast to attention-grabbing headlines around politics and the pandemic. They offer a real-time object lesson on how a cyclical vantage point can see through event-driven "noise.” Instead of being fixated on the progress of the pandemic, the latest news about vaccine development or stimulus negotiations – all of which influence day-to-day market gyrations – it’s far more useful to systematically monitor reliable leading indexes of the business cycle that cut through that noise and point to the true cyclical direction of economic growth.
Today, ECRI’s Weekly Leading Index (WLI) remains in a cyclical upturn. In fact, it turned up over eight months ago, as noted in our June article explaining why soaring stocks made perfect sense, despite all the negative headlines. The latest reading on WLI growth shows it’s risen to a 198-week high (chart below), meaning that – despite the surge in Covid-19 infections and uncertainty about fiscal stimulus – the economic recovery won’t be derailed.
Inflation's Steady Rise
Separately, our U.S. Future Inflation Gauge (USFIG) – designed to anticipate inflation cycle upswings and downswings – flagged the current inflation upturn over six months ago, as discussed in last month’s MacroVoices podcast. The USFIG is still rising.
Ultimately, the markets will do what they always do – which is to follow the ebb and flow of economic cycles. Meanwhile, the pontifications of popular pundits get jerked around from one event to another, leading CNBC’s late Mark Haines to once affectionately nickname a sermonizing colleague "The Reverend Jim Bob from the Church of What's Working Now." That’s entertaining, but it’s so much more rewarding, and less stressful, to follow the lead of reliable leading indexes that cut through this noise.
And on that score, the combined cyclical upswings in WLI growth and the USFIG still add up to the reflation trade.
ECRI's Anirvan Banerji contributed to this article.