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Lighthouse Macro Report - 2012 - November

Lighthouse Macro Report - 2012 - November

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Published by Alexander Gloy

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Published by: Alexander Gloy on Nov 16, 2012
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Lighthouse Investment Management 
Macro Report - US economic indicators - November 2012 Page 1
Macro Report
Economic Indicators - US economy - November 2012
Contents
Introduction .................................................................................................................................................. 2The past: oil & the Fed .................................................................................................................................. 3The Lighthouse Recession Probability Indicator (LRPI) ................................................................................. 5Annex: LRPI Components .............................................................................................................................. 8Building permits ............................................................................................................................................ 8Consumer Sentiment .................................................................................................................................... 9Total Credit Outstanding ............................................................................................................................. 10Electricity Usage .......................................................................................................................................... 11Consumer Confidence ................................................................................................................................. 12Retail sales .................................................................................................................................................. 13Manufacturing: Hours Worked ................................................................................................................... 14Manufacturing: Orders ............................................................................................................................... 15Miles Traveled ............................................................................................................................................. 16Orders: Capital Goods ................................................................................................................................. 17Electric and Gas Output .............................................................................................................................. 18Manufacturing: Supplier Deliveries ............................................................................................................ 19Gasoline ...................................................................................................................................................... 20
 
Lighthouse Investment Management 
Macro Report - US economic indicators - November 2012 Page 2
Introduction
 
Recessions are bad for company profits and hence stock prices. Knowing when an economic slow-downlooms can give important clues about asset class selection. Knowing it early is crucial for investmentperformance.In the US, recessions are "declared" by the NBER (National Bureau of Economic Research). The NBERdefines recessions as a "significant decline in economic activity spread across the economy" (not, asoften believed, as two consecutive quarters of negative GDP growth. Theoretically, a recession couldhappen without negative GDP growth, but it practically never has).The NBER takes it's time to date the beginning and the end of a down-turn; it announced the beginningof the last recession (December 2007) only on December 1, 2008 - one year later. By that time, the S&P500 Index had fallen from 1,575 points to 741.Similarly, the end of the recession in June 2009 was announced on September 20, 2010 - more than oneyear later. By that time, the S&P 500 had already soared from 940 points to 1,142.Waiting for the NBER to declare beginning and end of recessions would have led to inferior investmentresults (the NBER is correct in taking it's time, since many economic indicators are being revised multipletimes as preliminary data gets updated).Traditional leading indicators include values such as the stock market and the slope of the yield curve.However, the stock market does not seem very good at anticipating recessions, as the S&P 500 indexmarked an all-time high in mid-October 2007, a mere six weeks before the most severe recession of thelast 8 decades began.The yield curve has historically been a very good warning sign of recessions, as the Federal Reserve Bankwas forced to increase short-term rates in order to cool an overheating economy (thereby triggering arecession). However, with short-term interest rates near zero for the foreseeable future, the yield curvecould only invert if long-term yields dipped into negative territory. While not entirely impossible(negative yields for up to 2 year maturities have been observed in German, Swiss, Danish and othergovernment bond markets) it is very unlikely to happen in US Treasuries. Therefore, the slope of the USyield curve is unlikely to give any hints about a recession occurring under ZIRP (zero-interest-rate-policy).Indicators published by other institutions, such as ECRI (Economic Cycle Research Institute), areproprietary and not transparent, giving investors only the choice to "believe-it-or-leave-it".The Conference Board Leading Indicator includes questionable values such as the S&P 500 Index, theslope of the US yield curve and M2 money supply (which we have found to have little correlation witheconomic cycles).
 
Lighthouse Investment Management 
Macro Report - US economic indicators - November 2012 Page 3
As most recessions last rarely longer than a year, the economy usually had already exited a recession bythe time the NBER declared it to be in one.Revisions to GDP growth render it useless for investment purposes; On August 28, 2008 (already 8months into the "great recession"), Q2 2008 GDP growth was revised upwards from an initial +1.9% to+3.3%, triggering a 2% stock market rally. Later, growth was revised down to 1.3%, with the followingquarters delivering -3.7%, -9.2% and -5.4% (quarter-on-quarter, annualized). The S&P 500 Index didn'tsee its level attained that day for another 2 1/2 years.Finding a reliable indicator for identifying recessions "real-time" would already be a great improvementover waiting for the NBER.
The past: oil & the Fed
 
Over the past 50 years, every recession was easily explained by two factors: oil and the Fed.On the following page you will see how the US central bank ("Fed") increased interest rates ahead of each of the last 9 recessions. The black line shows the absolute level of the Fed Funds rate; the blue linethe increase from the prior post-recession low.Recessions are shaded in gray. Yellow dots indicate the beginning of a recession; green dots the end.The absolute level (black line) is usually on the right-hand scale, while percentage changes (blue line) areon the left-hand scale. Negative absolute numbers should be ignored as they are merely needed forbetter formatting.A significant increase in the price of crude oil can be found during 5 out of the last 6 recessions (see nextpage).

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