New Vanguard Economic Momentum Index: Economic Recovery is Near, Recession May Be Over

The general improvement in global financial conditions since March has fostered a marked improvement in investor sentiment and led many to inquire when (rather than if) the current U.S. recession will end. Increasingly, market commentary has focused on evidence of “green shoots” that would suggest the rate of economic deterioration is at least slowing. But how can we know that the right signals are being captured, and—more important—how accurate have such measures been in identifying the turning points of past business cycles?

In this brief, we unveil a proprietary Vanguard Economic Momentum Index consisting of more than 70 financial and economic indicators that in the past have anticipated (to varying degrees) the beginning and end of economic recessions. This new index is specifically designed to anticipate turning points in the business cycle, and it differs in important ways from several other widely tracked indexes of leading indicators. As of the end of May 2009, the Vanguard Economic Momentum Index indicated that a U.S. economic recovery likely will begin by the end of 2009.

Figure 1 below (click to enlarge) presents a “dashboard” of the individual components that make up the Vanguard Economic Momentum Index. The components are ranked in descending order based on their historical ability to forecast nonfarm payroll growth. For presentation purposes, they have been assigned colors based on these criteria:

Red: Indicator consistent with future employment losses at an increasing rate.

Yellow: Indicator consistent with future employment losses at a decreasing rate.

Green: Indicator consistent with future employment gains.

Components shaded either green or yellow in Figure 1 are considered evidence of so-called green shoots, since their most recent rate of acceleration is consistent with an eventual economic recovery. Yellow shading reflects a recent improvement in the component’s rate of change (i.e., its rate of decline has slowed, or its “second derivative” has turned positive).

Figure 1 shows a notable recent improvement in various economic and financial indicators, especially through May 2009. Some examples of such components are the S&P 500 Index, the shape of the Treasury yield curve, corporate bond spreads, and certain housing and manufacturing statistics. Encouragingly, the components near the top—those that have been the most anticipatory leading indicators of future economic conditions—have changed for the better ahead of those toward the bottom, although the improvement in individual indicators is far from unanimous.

Figure 2 below (click to enlarge) illustrates that after bottoming in November 2008, the index turned positive in February 2009 and continued that trend into March and April. This sharp reversal brings the index to levels that were associated with past economic recoveries. Indeed, by the end of May, the index was near the highs reached following the deep recessions of the mid-1970s and early 1980s. Based on historical patterns, the index’s climb suggests a high statistical probability that a U.S. recovery will begin by the end of 2009.

MP: Based on the pattern of this index over the last eight recessions, and especially in the four severe recessions of the 1970s and early 1980s, it looks very likely that the current recession might already be over, or will be ending shortly.

HT: Heather Brooks