Perils of Data du Jour Forecasting

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Friday's much stronger-than-expected employment report quelled talk of a new "soft patch" and concerns about a sharp slowdown -- or even a recession -- in the second half of this year.

Remarkably, such fears were stoked mainly by disappointing April releases on retail sales, industrial production, GDP and payroll jobs -- all coincident indicators that tell you nothing about future economic growth.

If you really believe there was a soft patch around mid-2004 and another one in early 2005, I invite you to look at GDP growth (four-quarter percent change, bottom line in chart).

Do you really see a soft patch anywhere? Or do you see what I see -- a fairly steady easing in growth over the past year following a downturn in the growth rate of ECRI's Weekly Leading Index (WLI, top line)?

But the markets have a data du jour approach to economic forecasting: Every day, they key off of so-called market-moving numbers that are implicitly placed on a bullish-bearish scale.

Never mind that the number may be a leading, coincident or lagging indicator, or none of the above. Or that it may relate to cycles in economic growth, inflation, or employment, but rarely all three. Such nuances are often lost in the rush to judge the data as bullish or bearish.

Most market participants just take the data du jour and extrapolate them indiscriminately into the future, sometimes using backward-looking data to generate unwarranted gloom.

The penalty incurred by such an approach is misjudgment of the direction of future economic growth. Eventually, markets do get it right -- at least well enough for Paul Samuelson to quip that the stock market has predicted nine of the last five recessions.

Remember the 1987 stock market crash? Many felt at the time that this was evidence of an imminent recession. The reality? GDP grew by almost 4% in 1988.

What 'Soft Patch'? In reality, there's been nothing more worrisome than an easing of growth

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Source: ECRI