1 Tool That Forecasts Recession Has Perfect Record

Oh gee, not only do bulls have to worry about how the CAPE index has risen above 30, historically a signal of an impending market correction. And not only do they have to be skittish about Nvidia hitting a $2 trillion market capitalization, leaving Meta and other Magnificent 7 stocks in the dust on valuation, but they also have another tool with an impeccable track record to worry about.

The Conference Board Leading Economic Indicator isn’t as well known by retail traders as Shiller’s CAPE index, but that shouldn’t detract from it because its accuracy speaks for itself. And what it says now may cause bulls to shudder.

Key Points

• An indicator that is not widely followed but has a strong correlation of forecasting recessions reveals concerning data.
• If the indicator is right, the odds of a recession taking place in the near future is very high.
• So far the market has not priced in the bearish news, but when it does expect the move to be fast and furious.

What Does The Indicator Reveal?

It’s hard to find a crystal ball in the market that can be trusted, which is why investors cling to tools that correlate strongly with the timing of market peaks and troughs.

For example, one indicator that seems to peak when the market plunges and bottoms is the volatility index, which often spikes above 50 following major market bottoms.

Another, less widely followed, is the Conference Board Leading Economic Indicator, which is released monthly and sums up ten key inputs, including average manufacturing hours and average weekly unemployment claims.

As these key inputs vary so too does the output, which aims to spotlight when major turning points are occurring in the business cycle.

What Does LEI Forecast Now?

The scary statistic revealed by the LEI now is that for two months shy of two years, every month has been negative, a phenomenon that was rivaled in the 1970s, coincidentally at a time when inflation started to soar and stagflation ultimately took hold.

It turns out that it’s not in fact the longest streak of monthly consecutive declines. That award goes to the Great Recession when two years straight of monthly declines were evident.

But while the streak of declines is worrisome, a more concerning statistic observed by Fool is that declines exceeding 4% year-over-year have strongly correlated with US recessions. So good is the correlation that it’s perfect, meaning every single time over the past six decades that a YoY decline of that amount or more took place, a recession followed.

What the LEI signals is that the economy may well be on the cusp of entering a recession, so what about the stock market?

Will the Market Fall?

Typically, the market is viewed as a forecasting mechanism that looks out in time. So if rosy signs lie in the future for a stock or index, the market will anticipate the good news and move accordingly higher. Equally, if clouds loom up ahead, it is believed to price in the bearishness and fall.

For now it seems the market has risen to exuberant levels and doesn’t appear to be pricing in any bearishness whatsoever. But evidence is growing that the economy may hit road bumps soon, and that is likely to translate eventually to a bumpy stock market.

As the old saying goes, markets climb up a wall of worry but fall down the elevator shaft. When it goes red, it’s likely when people least expect it, but it can come quickly and furiously.