Little-known Fed index may be signaling recession

A new Federal Reserve report should raise deep concerns, but here's how to put them in context.

By StreetAuthority Jun 25, 2013 2:58PM
Hisham Ibrahim, CorbisBy David Sterman

Over the past year, economists have noticed an unusual pattern as they digest the series of monthly reports on housing, consumer confidence, purchasing managers, trade flows and other key economic inputs.
These reports showed consistently mixed signals, though it was clear that the U.S. economy was faring OK. And that has led to hopes of more consistently positive reports in the second half of 2013 and into 2014. By next year, many economists have come to expect a firmer backdrop, with GDP perhaps growing in the 2.5% to 3% range.

Yet it may be time to start questioning that brightening outlook. Perhaps the greatest measure of economic activity -- one ignored by most investors, unfortunately -- is flashing yellow and may soon be flashing red.

85 inputs
While many economic surveys aim to capture a slice of the U.S. economy, the Chicago Fed's National Activity Index (CFNAI) looks at 85 different economic inputs focused on production, income, employment, personal consumption and housing. A quick snapshot ( of the most recent reading actually shows a slight improvement from the previous month.

Yet economists at the Chicago Fed emphasize the importance of looking at longer-term trends rather than monthly snapshots. That's why they suggest that the three-month moving average of these reports is where you should focus -- and by that score, the CFNAI is in trouble.

CFNAI 3-Month Moving Average

Source: Federal Reserve Bank of Chicago

Though the CFNAI began the year in positive territory, it has recently slipped below negative 0.40. Note that the Chicago Fed believes that a reading of negative 0.70 signals entry into a recession, and we still have a ways to go before that happens.

In addition, the current slide could prove short-lived. After all, this index slid to negative 0.49 in October 2012 and then rebounded. Back then, the economy was looking tenuous as businesses and consumers were frozen by fears of a possible government shutdown (which never came to pass).

This time around, gauges of consumer activity appear to be holding their own, but several business gauges -- such as the purchasing managers' index, sales trends and inventory changes highlight a slowly weakening business sector.

The question is whether the ongoing challenges in Europe, the incipient slump in China, Brazil and elsewhere, and the impact of our own sequester will lead to further weakness in the business sector. This is an issue that you should be closely monitoring if you remain fully invested in the stock market, especially if you're holding economically sensitive stocks.

Later this week, a number of Federal Reserve members will be weighing in on the economy, including:
  • Minneapolis Fed President Narayana Kocherlakota, speaking on Wednesday in Seoul
  • Fed Governor Jerome Powell speaking on Thursday at the Bipartisan Policy Center
  • Atlanta Fed President Dennis Lockhart speaking on Thursday in Atlanta
  • On Friday, three more Fed presidents -- Jeffrey Lacker, Sandra Pianalto and John C. Williams -- will speak about the economy at various public forums.
  • Interested investors should track these economists this week, as they may shed more light on what appears to be a slowing U.S. economy.

Earnings season commentary
Of course these Fed governors and presidents will be weighing in just as many companies are finishing up their second quarter and preparing to give their outlooks for the remainder of 2013. At this point, it's hard to see how the coming earnings season commentary will be optimistic. To be sure, expectations going into each of the past few earnings seasons have been dim, and companies have delivered guidance that was not nearly as dire some had feared.

My biggest concern: The sharp recent weakening in many currencies could lead U.S. multinational firms to trim expectations as foreign sales are denominated back into dollars. On a related note, how will recent turmoil that has emerged in China (banking liquidity), Turkey and Brazil (social unrest), and Greece and Italy (spiking bond yields) affect company outlooks?

Risks to Consider:
As an upside risk, the CFNAI could rebound as we move past the effects of the recent government sequester.

Action to Take:
Although the Chicago Fed's National Activity Index dipped to similarly concerning levels in October before rebounding, you shouldn't dismiss this current reading. Prior to October, the last time this reading was less than negative 0.49 was back in 2008 and 2009, when the economy was on extremely tenuous ground. Though it's unlikely that we'll see as sharp an economic slump as we did back then, it's becoming harder to rule out at least a mild recession in coming quarters -- which is food for thought with the major market averages still near all-time highs.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

More from StreetAuthority

Tags: $DJI$SPX
Jun 25, 2013 3:18PM
When, exactly, did the recession really end??????????
Jun 25, 2013 3:47PM
The recession ended sometime in the middle of 2009. The problem is the meaning of recession. If the economy is growing then no recession. In other words it has nothing to do with the economy being good or bad. Only if it is GROWING or SHRINKING. I think everyone agrees the economy is bad. Except for autos, guns, ammo, the repo man, and of course Wall Street it seems everyone else is worse off than 2009.
Jun 25, 2013 9:40PM
I thought the Obama way was working. Did he and Biden lie again? Will they blame Bush in the 2016 elections still?
Jun 25, 2013 4:34PM
LMAO The only thing keeping the US economy at plus growth is QE3. Housing is going to tank even if they just hint, as they have, at stopping QE3. Without housing the economy is going to feel the full wrath of budget cuts next year not just this years 78% version Uncle Ben don't care he's going to do something that pays better and is a lot more interesting.
Jun 26, 2013 7:53AM
If you could lay all the economists in the world end for end ..... 

It would be a very good thing.   
Jun 26, 2013 7:10AM

I sense a growing negativity in the Media. That same media that was so adoring of Obama. They must be finally realizing that Socialist Muslim Lord Obozo is not the answer.

Jun 26, 2013 8:18AM

The economy will never improve until Washington puts the clamps on outsourcing - both goods and jobs. You eliminate a $60K per year paycheck and you've eliminated $60K per year in spending and income taxes. It's rocket science folks...

Jun 26, 2013 9:27AM

Recession is negative GDP growth.  Historically, recessions are followed by robust growth.  The econcomy is bad because the recovery has been very weak.  The data shows that the economy is growing at a snails pace since the recession.  That makes it feel to the public as if the recession never ended. 

Jun 26, 2013 4:32PM
Wow, someone(clone#?), you really think it's that easy to label and make it stick. Fact is, you are clueless to what if any party I belong to. But since you feel the need to spread misinformation, lets address your fool hardy comments.

1)Until there is a War Tax on those that pushed for these farce wars but refuse to send their sons and daughters, don't go telling me about the Bogus unfunded wars, now or then. Fact is, Bush started this whole thing about unwarranted spying on Americans and clearly started the two wars of Profit. I have also stated often that I disagree with both Bush and Obama on the issue of spying. The Wars, it's complicated to just withdraw once we have invested so much money and LIVES. But we we will leave both at some point.

2)Big Oil hasn't gone away, like duh, how long did it take you to figure that out.

3)Corporations showing Record Profits and Cash hoards yet nothing to show for it? You are a fool. The FED via low rates and bailouts have boosted Corporations yet they are refusing to pass along their benefits via the FED to real workers. Of course, you are fine and dandy with that.

4)Stimulus is here to stay due to the 500-700 Trillion plus in Scam Derivatives via the Bush Two Terms. I would explain it to you but clearly a fool like you would never understand.

I have never claimed to buy the kool-aid that Obama is selling and have pointed out at times that if anything, Obama is Bush term 3 and 4. However, when buffoons like you say there is no recovery, that simply means you know nothing about what has happened in the Economy, now or then. Fact is, talking to clones like you is pointless, you talk a ton but know very little about the economy or anything else.

Jun 25, 2013 11:45PM
Jun 26, 2013 2:30AM
So the same folks laughing about when did the recession end are the same folks telling everyone that one, the Government should be firing everyone and two, most Corporations should be doing the same. To top that off, they also say any workers left should have their pay reduced, dramatically. However they defend to the death any and all pay increases to the useless CEOs. Yep, there was over an Decade of Class Warfare, the Middle-Class lost big time.
Jun 26, 2013 2:13AM
So wow, it only took 500 Trillion plus in scam derivatives to keep the Bush economy humming along. How do you fix that? Don't forget the massive profits of Big Oil and how their gouging has cost the economy. How about those two unfunded wars? The party of blame all things Obama is alive and well. God help America.
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