iM’s Business Cycle Index Recession Warning Hardened – Update 1/28/2023

The U.S. Census Bureau substantially down revised the November “Houses for sale” and “House sold” estimates with their latest December release. This substantially down revised the BCI hardening the recession warning.

The BCI at 260.9 is near last week’s down revised level 261.0 lowering the BCIp to 20.5 (see Figure 1, magenta curve) and from past performance a definite recession is signaled not earlier than 12 weeks but not later than 25 weeks. BCIg, the six-month smoothed annualized growth rate of BCI now at 0.6 is near its recession signal trigger. (see Figure 1, blue curve). When BCIg crosses zero from the upside, then from past performance, it signals a recession with an average lead of 12 weeks.

iM’s Business Cycle Index Description

In 2013, we developed our Business Cycle Index from the following basic economic data:

1. 10-year treasury yield (daily)
2. 3-month treasury bill yield (daily)
3. S&P 500 (daily)
4. Continues Claims Seasonally Adjusted (weekly)
5. All Employees: Total Private Industries (monthly)
6. New houses for sale (monthly)
7. New houses sold (monthly)

The complete data-set is available on FRED from 1967 onwards. When combining the components for the index the “real-time” aspect was considered, i.e., the data was only incorporated into the index at its publication date and not at the date shown in the series.

The BCI on its own does not provide recession signals, but after further manipulation of the series two indicators are extracted that reliably signal looming recessions:

1. The six-month smoothed annualized growth rate of an economic series is a well-established method to extract an indicator from the series. We use this method to obtain BCIg (growth). Here BCIg is the calculated growth rate with 6.0 added to it, which generates, on past performance, an average 11-week leading recession signal when BCIg falls below zero.
2. We also found that the BCI retreats in a well-defined manner from its cyclical peak prior to recessions. This allowed the extraction of the alternative indicator BCIp (deviation from previous peak of BCI). Past performance shows that on average 20 weeks prior to a recession, the BCIp value crossed 25 to the downside.
3. In our 2014 article, iM’s BCIw: A Weeks to Recession Indicator, we show how the BCIp (deviation from previous peak of BCI) indicator can be transformed to a BCIw (weeks to next recession) derived from the previous BCIp tracks to the NBER defined recession.

The two indicators BCIg and BCIp could be used as a sell signal for ETFs that track the stock markets, like SPY, IWV, VTI, etc., or stocks in general.

In Table 1, we record for each recession the pre-recession peak of the S&P 500, the value on the day of the BCIg signal, and the subsequent lowest value of the inter-recession trough. From these, we calculate the loss avoided by exiting the market on the day of the BCIg signal.

Table 1: Loss avoidance in SPY when exiting on BCIg recession warning.
Note	1	2	3	4	5	6	7	8
Recession	Peak	Signal	Trough	(P-T)/P	(S-T)/S	(P-T)	(S-T)	(S-T)/(P-T)
Jan-70	106.16	93.24	69.29	36.1%	25.7%	36.87	23.95	65.0%
Dec-73	120.24	103.36	62.28	48.2%	39.7%	57.96	41.08	70.9%
Feb-80	115.2	100.3	98.22	17.1%	2.1%	16.98	2.08	12.2%
Aug-81	140.52	128.64	102.42	27.1%	20.5%	38.1	26.22	68.8%
Aug-90	368.95	332.92	295.46	19.9%	11.3%	73.49	37.46	51.0%
Apr-01	1520.77	1326.82	965.8	36.8%	27.2%	554.97	361.02	65.1%
Jan-08	1565.15	1508.44	676.53	56.8%	55.2%	888.62	831.91	93.6%
Average all recessions				34.6%	25.9%			60.9%
Column Notes: S&P 500 peak during 1-yr period before recession S&P 500 at iM-BClg signal date S&P 500 trough during recession %-Loss from Peak to Trough %-Loss avoided from Signal to Trough Absolute loss from Peak to Trough Absolute loss from Signal to Trough avoided % of loss from Peak to Trough avoided

Click to enlarge

Following the BCIg signals from our recession indicator, one would have avoided on average about 61% of the total market decline from pre-recession peaks to inter-recession troughs, as indicated in the last column of Table 2. One can see in column 5 that exiting the market at the signal dates would have avoided losses averaging about 26%. Had one known the market peak, one could have avoided the 35% average decline as shown in column 4. Prior to the 2008 recession, the exit signal from BCIg occurred almost when the market peaked.

Figure 3 plots the history of BCI, BCIg and the LOG (S&P 500) since July 1967, and Figure 4 plots the history of BCIp, i.e., 56 years of history, which includes eight recessions, each of which the BCIg and BCIp managed to indicate timely; the weeks leading to a recession are indicated on the plots.