In a previous post I highlighted a small example of how the Onalytica Recession-Index gave a good indication of an impending recession in the UK.
However, I haven’t had the opportunity to conduct a more thorough analysis so I recently asked my colleague, Dr. Andreea Moldovan, to have a look at the Onalytica Recession-Index in relation to GDP. Her findings impressed me.
Figure 1 (below) shows the UK GDP against Recession-Index for UK Economy. The values for GDP are given in quarterly percentage (or relative) change on previous quarter.
The Recession-Index is a 1 month leading indicator and the values on the chart already contain the lead, i.e. Recession-Index at Q1 2010 contains actually data from Dec '09 to Feb '10, etc.
The series have different scales and are represented on different vertical axes, for ease of chart interpretation. The left vertical axis corresponds to the Recession-Index values, while the right axis is for the GDP.
Since Q1 2010 and except for Q4 2010, the Recession-Index correctly predicts the UK GDP direction of growth (increase or decrease) 1 month ahead. On the chart this is reflected by the series having opposite directions: decrease in Recession perception by the population corresponds to a growth in GDP and vice versa. So, in 8 out of 9 situations analysed the prediction is correct.
The lead of the Recession-Index is in practice more than 1 month as the GDP values are announced some time after the end of the quarter.
The same analysis for the US Economy and the conclusion is the same, that the expectation (or fear) of a recession by the population can be used to predict 1 month ahead the direction of growth rate (increase or decrease) of the US GDP.
Figure 2 (below) shows the quarterly values of US GDP (2011 revision) against the Recession-Index in the context of US Economy. As before, the Recession-Index already contains the 1 month lead on the chart, i.e. the Q3 2008 value actually refers to Recession-Index data for Jun '08 - Aug '08, etc.
This time the period analysed is longer, from Q3 2008 to Q2 2012. Except for Q4 2010 and Q3 2011, the Recession-Index is a 1 month leading indicator for the direction of US GDP growth rate (increase or decrease).
In summary, the Onalytica Recession-Index for UK and US respectively predicts the direction of the country’s GDP one month out in 87%(US) to 89%(UK) of the analysed quarters. I would not be surprised if a model, which takes a few more signals (maybe another Onalytica Index) could make the correct prediction every time. Stay tuned!