Insights on ECRI: Is This Stock-Market Prophet Calling for a Double-Dip Recession?

The Economic Cycle Research Institute - referred to as the "ECRI" by anyone in the know on Wall Street - has correctly called every U.S. recession during the last 45 years.

To work its magic, the ECRI charts the weekly changes in an index of Leading Economic Indicators (WLI). Market professionals like myself very quietly use the same group of indicators to call market tops and bottoms. The indicators are so accurate in terms of what they have to say about the future that I refer to ECRI and the WLI as "The Prophet."

Given the Prophet's 100% hit rate over the last half century, investors should definitely take heed of the warning signals that this economic seer of seers is making right now.

Insight on ECRI

It's pretty likely that most retail-level investors have either never heard of the ECRI, or are aware of the organization but just don't really know what it does. And that's understandable: Up to now there's probably no real reason for ECRI to have been on your radar screen.

But it's time for that to change.

The ECRI was founded bythe late Prof.Geoffrey H. Moore, who in 1950 developed a list of leading indicators for recessions and recoveries. He followed that up with a composite index in 1958 and what we now call the LEI (Leading Economic Indicators) in 1967.

The ECRI is an independent institution dedicated to forecasting the turning points in an economy. It maintains about 100 proprietary economic indices. One of them - the WLI - is extremely good at calling tops and bottoms in the economy. The ECRI has a 100% hit rate and is right now warning anyone who will listen that another downdraft is in store for the U.S. economy.

In short, it's telling us that it's time to start worrying about a "double-dip" recession.

The WLI updates include a rate of change, which is what I want you to focus on going forward. When the real economy is growing, this indicator has a "positive" reading - meaning it provides a reading greater that "0."

When an economy is starting to slow down internally - and starting its slide toward recession - ECRI's WLI index will show a year-over-year negative change in the readings. This rate of change will go "negative" suggesting a slowdown in the economy. When the rate of change reaches a negative 10%, historically, a recession has broken out.

Let's take a closer look.

As we noted, a negative reading in the ECRI is telling. But going all the way back to 1965, every time ECRI reported a rate of change of "negative 10" or more, a recession has started within a couple of months. Each time, without fail, ECRI has been able to warn the investors who were listening that the economy was slowing down - and that a recession was in the offing.

What's 'The Prophet' Saying Now?

ECRI has yet to declare a double-dip recession. However, ECRI's WLI index - which has a 100% record of calling a recession when it hits negative 10% - is currently sitting at negative 10.7%. And the index has been sitting in this traditional, recessionary territory for two weeks.

Believe me when I say this: The institutional players are paying attention. Even if the ECRI has not said it yet.

"I have to pay attention to those people and indicators that have pointed in the right direction - whenthey've gone against the crowd (and my opinion at the time)," said Barron's columnistRandall W. Forsyth. "One such outfit is the Economic Cycle Research Institute, whose various leading indicators actually have done just that - lead where things were headed."

Just below is a chart that compares the weekly closing price of the Standard & Poor's SPDR S&P 500 exchange traded fund (NYSE:SPY) with ECRI's Weekly Leading Indicator (WLI) Index. In red, just below that, is the year-over-year rate of change in the WLI weekly reading.

This rate-of-change statistic is closely followed by Wall Street, since it gives investors the best feel for how the economic outlook has changed over a period of time. Right now, it seems to be telling investors that the economy continues to have internal weakness - enough, in fact, for the statistic to have reached what historically has been recessionary territory.

We intentionally decided to look at the period since July 2006 so investors could get a feel for how these indices related to each other - both before and after financial-crisis-related events of 2008.

For instance, it's especially worth noting that the ECRI index bottomed in December of 2008 - a full three months before the stock markets both here and abroad hit the bottom. Much like the Baltic Dry Index (BDI) thatwe explored in a popular Money Morning essay several weeks ago, the WLI also "called" the economic bottom during the 2008 meltdown.

Even more interesting: The WLI bottomed just as the BDI index also bottomed in December 2008. Combined, they provide investors with a "real" insight into what's happening in the markets.

This time around, the ECRI WLI update has dropped every week since April 30. The index peaked at a positive "24" back in September 2009, in part reflecting the historic rebound that U.S. stocks had posted in their run-up from the March 2009 market lows.

ECRI's strategy - in which its analysts document the regular up-and-down cycles of an economy, while also tracking the forward-looking indicators - has given this organization an unparalleled edge over its potential peers.

The "tops" and "bottoms" of aneconomic cycle are reached time and again, typically in the same manner. While the players change - as one presidential administration leads to another, and the leading investment bank of one era is subsumed by the leader to come - the signs of an economic slowdown really don't shift from one period to the next.

This is why I want you to follow those "signs" - which include ECRI's WLI, and the BDI. These are some of the tools that professional investors - like myself - employ as part of their never-ending quest to remain ahead of the market, and "the crowd."

You can put "The Prophet's" work to good use. And you don't even have to pay for the "service" that institutional players sign up and shell out for. That's because ECRI makes all its information available on site. You can download it for free each Friday: Just savethis link and click on it each Friday at around 11 a.m.

Action to Take: Review your domestic equity positions with an eye toward booking any long-term capital gains "profits" you have. You will want to have cash available to fund your return to market, once the BDI & LEI (WLI) say it's safe to be "long" in the U.S. stock market again. The old market adage that "you never go broke taking profits that already exist" may be truer today than at any time over the last 100 years.

Additionally, I would suggest that you might wish to set up for an account at Google.com (Nasdaq: GOOG), and sign up for free Google news alerts. Plug in "ECRI" as the topic and pick the once-a-day update option. This will get you a daily e-mail containing links to any articles quoting the ECRI or the different index information that this organization provides to professional investors. It is a great way to follow "The Prophet" in real time - and for free. How many other things can you make that kind of claim about these days?

[Editor's Note: Jack Barnes started his career at Franklin Templeton in 1997, working in its fund-information department - just as the Asian contagion infected the Asian tiger countries. He launched his own RIA shop in 2003 just as the second Gulf War was breaking out. In early 2006, after logging a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008. Last summer, Barnes retired to the beach - which is where he writes from now.]

News and Related Story Links:

• ECRI:
  Official Website.
• Wikipedia:
  Leading Economic Indicators.
• ECRI LEI data updated weekly:
  http://www.businesscycle.com/files/ecri_data/uswliw.xls.
• The New York Times:
  Obituary of Geoffrey H. Moore.
• Money Morning:
  The Baltic Dry Index is Shouting "Danger, Will Robinson!" But Are Investors Listening?
• Library of Economics and Liberty:
  Recession.
• Barron's Randall W. Forsyth:
  Compendium of Columns.
• InvestorWords:
  Economic Cycle.