Many eyes are on the McKelvey recession indicator. Too many? That would probably be the case if everyone believed it.
What is the McKelvey Recession Indicator?
Take the current value of the 3-month unemployment rate average, subtract the 12-month low, and if the difference is 0.30 percentage point or more, then a recession has started.
Edward McKelvey, a senior economist at Goldman Sachs, created the indicator. The problem with the indicator is that it has many false positives.
Claudi Sahm Modification
Claudi Samn, a former Fed economist, revised the rule, claiming it as her own, without credit to McKelvey, then set the indicator to 0.50.
Because that still had false positives, she started her series in 1960.
McKelvey Improvements
Improvements to the model by Pascal Michaillat and Emmanuel Saez, economists at the University of California in Santa Cruz, eliminate all false negatives and all false positive dating to 1951.
I referred to their improvement as PMES based on their initials. I am not sure that PMES is right but somehow I don’t think the name McKelvey-Michaillat-Saez will catch on.
Please see Key Recession Indicator Gives Stronger Recession Signal in August for discussion of the Pascal Michaillat and Emmanuel Saez PMES improvements.
PMES Update
On Friday, following the BLS jobs report, Pascal updated the indicator : Has the Recession Started?
He says “With August 2024 data, our indicator is at 0.54 percentage points, so the probability that the US economy is now in recession is 48 percent. In fact, the recession may have started as early as April 2024.”
I calculate 0.54 independently, but in my post I said “I will take the over line on 48 percent odds.“
On Saturday, I had an Email exchange with Pascal on calculating the odds. It started with an observation of Pascal that struck me as wrong.
Pascal: “When the indicator is below 0.3 percentage points (pp), a recession has not started. When the indicator is above 0.8pp, a recession has started for sure. When the indicator is in the 0.3pp–0.8pp band, a recession is likely to have started.”
Mish Note: At the time I emailed Pascal, I did not have a suggested alternative, but I have one now, described below. First, consider the email exchange.
Email Exchange Mish to Pascal
Hi Pascal, I believe your probability calculation is wrong.
Your statement “When the indicator is below 0.3 percentage points, a recession has not started,” is observably false.
Here is a table of actual conditions when recession started.
Three out of 11 recessions started with both McKelvey and PMES below 0.1!
The likelihood may be small but it is nonzero and happened 3 times.
In general, any time both indicators are nonzero, there is a nonzero chance.
Also note 8 of 11 recessions started with McKelvey below 0.3.
The area approach >.3 and <0.8 to arrive at 48 percent strikes me as incorrect.
I think the scale should be a log scale. 1960, 1973, and 1981 are especially problematic for your area rule.
We have eliminated the false negatives and false positives, but I think we need work on probabilities. By the time both indicators are >0.5 I am pretty sure the odds are greater than 48%.
Think of a Richter Scale with earthquakes. I suggest the odds of damage (recession) increases in a non-linear fashion as both indicators get above a certain level.
The medians values are 0.26 and 0.42 in isolation. And those are long ago in the rearview mirror simultaneously.
Pascal Email Response
Hi Mish, Thank you very much for your note.
So far we use a linear probability by lack of anything better. But I agree with your intuition that it might better to use a nonlinear probability.
We will think about it, and I will of course keep you updated. I have a lot of work this month, so this will probably have to wait a few weeks.
Mish Note: Following that response I came up with the idea on how to do this.
How I Calculated the Odds
- Count all the occurrences of a McKelvey indicator >0 but <0.1.
- Do the same for every range in increments of 0.1 percentage points.
- Repeat steps 1-2 calculating a 0 or 1 value if the economy was in recession.
- Divide the counts of steps 3 by the results of steps 1-2.
Results
- >0 <0.1: 4 recessions in 140 occurrences, 2.86 percent
- >=0.1 <0.2: 3 recessions in 69 occurrences, 4.35 percent
- >=0.2 <0.3: 5 recessions in 45 occurrences, 11.11 percent
- >=0.3 <0.4: 9 recessions in 26 occurrences, 34.62 percent
- >=0.4 <0.5: 9 recessions in 17 occurrences, 52.94 percent
- >=0.5 <0.6: 7 recessions in 9 occurrences, 77.78 percent
- =0.6 <0.7: 5 recessions in 10 occurrences, 50.00 percent
- =0.7 <0.8: 3 recessions in 8 occurrences, 37.50 percent
The last two lines are counterintuitive. But the cause is very elevated McKelvey indicators after recession has ended.
For example, following the end of the 1957 recession, there were 9 consecutive months in which McKelvey indicator was above 0.7 but there was no recession. Five of those numbers were above 3.0.
This implies the odds in my chart may be a bit low as numbers get higher.
There are a few ways to fix this. One way is to discard all results for x number of months following recession. Alternatively, and likely better, discard all results following recessions until the signal resets at a McKelvey reading of <0.3.
A simpler way is lop off the lead chart where I did and call it a bargain on the basis we are dealing with imprecise BLS data to say the least.
I had previously suggested using 0.4 percent as a trigger and the above calcs suggest 0.4 is very near the 50-50 tipping point.
Bear in mind, even with the PMES modification, the combined indicator is still lagging (trails the actual start of recessions). This explains the three recessions that start with both McKelvey and PMES below 0.1.
Getting rid of false signals created a problem in calculating the odds. I believe my method or something close is the solution.
Finally, please note that my calculated odds do not factor in the second indicator. The addition of the second indicator logically increases the odds above what I came up with.
Where Are We Now?
I have McKelvey at 0.54 and a confirming PMES of 0.74.
This is suggests a recession probability of ~77.78 percent. Those who seek a margin of error, perhaps based on the idea of imprecise BLS data, might look at overlapping ranges.
If so, I suggest a range of ~53 to ~78 percent, say ~65 percent vs the Pascal calculation of 48 percent.
The key idea is recession probabilities are a non-linear function of rising recession indicators.
Pascal said that recession may have started in April. In April, I have McKelvey at 0.34. That puts the odds at 35 percent straight up.
It would take some huge (but possible) negative BEA revisions to get there. June or July looks more likely on the basis of this analysis.
My Recession Rule Was Meant to Be Broken
One of the more amusing things is Sahm believes the indicator she popularized (but did not invent) is now giving a false signal.
Bloomberg reports My Recession Rule Was Meant to Be Broken
Sahm: While the economy is growing less quickly, it is growing. There is no recession, at least not yet.
But conditions can change quickly, and by the time the NBER has officially designated a recession, it is usually too late to guide policymakers. The purpose of the Sahm rule is to act as a kind of early diagnosis. I created it in early 2019 to shorten the wait time on the NBER and act as an automatic trigger for fiscal policy, such as stimulus checks, in a downturn.
Sahm did not create the indicator, she modified an indicator created by Ed McKelvey, without credit, (perhaps inaccurately, resulting in strange negative numbers). My calcs have no negative numbers nor do PMES calcs.
The idea of “automatic stimulus checks” is just plain ridiculous. We are in this mess because of stimulus checks.
Fed and Congressional over- and underreactions have created boom-bust cycles of increasing amplitude over time.
Too Many Eyes?
Many eyes are on the McKelvey recession indicator. Too many?
That would probably be the case if everyone believed it. In this case, heck, not even Sahm believes it.
Supporting Factors
September 3: Construction Spending Growth Slows in May, Stops in June, Negative in July
September 6: Payroll Report: Manufacturing Sheds 24,000 Jobs, Government Adds 24,000, Big Negative Revisions
September 7: BLS Negative Job Revisions 15 of Last 21 Months
September 9: Fed Beige Book Conditions Are Worse Now Than the Start of the Great Recession
What is the name of the law when
Law of Nitpicking?
Could go with Cassandra’s Law.
Although I’d also support calling it DeNile’s Law.
Remember, economists are not licensed by the state, such as the woman that cuts my hair and the doctor who delivered my children. If only the economy could be reduced to the variables of landing a woman on Mars.
Ilan, Zuk and Bezus support Trump.
The probability based on PMES is near 100%. The logic you have to follow is when PMES is low and then rises, how often is there NOT a recession at that time or soon after? The answer is NEVER – there are no false positives in the series. The only reason for a probably < 100% is if you think there’s a chance Sahm et al are right and the indicators are being fooled by the current “this time is different”. I’m not in that camp … partly because other proper leading indicators are also calling out Recession now.
You could estimate the probability of a false positive by looking at the number of accurate triggers and near-misses in the data series, and say that while the PMES has caught, say, 13 of 13 recessions since 1950, maybe it could’ve been wrong once and maybe it could be wrong now, so the worst-case track record it could have after this is 13/15, which means at least an 87% chance that we are in the early stages of a recession right now.
P.S. Most people don’t want to believe this because their livelihoods and portfolios will be damaged by it being true. But I think the Smart Money has already adjusted their expectations and repositioned their portfolios to minimize the damage.
Dollar Tree and Family Dollar stock prices just tanked and Big Lots just filed for bankruptcy. I’m guessing that is a pretty good indicator.
Those are stores that all cater to the low end consumer. We already knew they have been hurting for a while now due to inflation.
How is Costco, American Express and Apple doing?
We’ve had two economies for a while now, the high end and low end. One is doing well, the other is not.
What is the name of the law that says that says indicators lose their usefulness when they are used by too many people?
What is the name of the law when
Law of Nitpicking?
“Goodhart’s law is an adage often stated as, “When a measure becomes a target, it ceases to be a good measure”.”
For a lot of people it already feels like a recession, or worse, due to the loss of purchasing power. Things are getting way out of hand for a lot of people.
The odds that we are in a recession now – VERY HIGH
The odds that the Obama staffed NBER declares a recession this year – VERY LOW
The odds that the NBER declares a recession during Trump’s second term – 100%
Well, the market is not pricing one in so they have the odds at pretty much zero. The asset prices remaining high buys A LOT of time to weather slow downs and perhaps that reflexivity is keeping recession away as paradoxical as that sounds. Fiscal policy though is a trainwreck and monetary policy has been sat on for decades.
There is no recession. Still see jobs advertised on trucks, etc. Maybe a bit of a slow down, but no recession. When I see prices on real estate drop 30-50% then I’ll believe it. Ain’t happening in the Central Valley. Prices still way up. Also, prices on goods still up. Inflation is here to stay. Not no 2% per year garbage that the idiots spew. How about 50-100% over the last several years. We are stuck with that. Less money for buying junk you don’t need. My cash is pretty much going towards: food, utilities and other bills, insurance, a home loan, and home repairs. Very minimal for clothes and other less critical stuff. Gonna be a tough Christmas!
Well, the market is not pricing one in so they have the odds at pretty much zero.
That is false
And I have already discussed it
The Stock market often peaks right around the start of recession
Was someone saying China is not F789ed??
After enduring almost a quarter-trillion dollar hit to their market value in recent months, Europe’s luxury firms may see their stock-market clout wane further as China’s downturn worsens.
Once seen as Europe’s answer to the US “Magnificent Seven” tech megacaps, shares in companies producing high-end clothing, handbags and jewellery are languishing, sapped by a spending slump. Even more ominous are signs that China’s rich, who once flocked to upscale boutiques in Paris, Milan and Hong Kong, may not return, their appetite for pricey items extinguished by the economy’s downward spiral.
“This year is more volatile and more painful because it comes after this excessive growth,” Flavio Cereda, an investment manager at GAM UK Ltd. said, referring to the period immediately after the pandemic when consumers liberated from lockdowns splurged on shopping and travel.
For Britain’s iconic raincoat maker Burberry Group Plc, it’s culminating in ejection from London’s FTSE 100 stock index, with its market value down 70 percent in the past year. While it’s the only major brand to lose its index slot, an gauge of luxury shares compiled by Goldman Sachs has shed $240 billion in value from a March peak.
https://www.businessoffashion.com/news/luxury/european-luxury-shares-240-billion-rout-is-just-the-beginning/
The Beige book : declined slightly x4 times, contracted slightly x1. No deterioration, no contraction. Consumer spending is rising, all businesses 1-500+ are hiring workers, ex 1-49 in equilibrium. No contractions. The actual GDP, including 6 millions new immigrants, is rising. Debt/GDP is falling. NTR and ATRR are falling. Negative rates are back.
That was literally the worst “non-recession” Beige Book since the ones in the early stages of the 2007-2009 recession (before the recession’s start had been acknowledged)…
Even as the inflationary depression pounds on, crushing everyone in it’s path, the monetary supported sector hopes to escape the dreaded big ‘R’.
Evidence in Real Estate starting to rise of the impending debt liquidation phase. Far too much debt to service, foreclosures and Lis Pendens rising in certain areas.
Objective for the individual is to get through this phase and emerge whole on other side.
It will be feeding back into economy as Housing chills and all that consumer demand accompanying Home ownership contracts.
In the end only when Banking system starts to get rocked will they go back to print mode. For now Fed is of mind there is enough Bank reserves in system to cushion shocks of defaults.
Where does the NBER COME IN?
Is this not like, “They don’t say Hanes unless I say they say Hanes.” ?????
#overfitting