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By New_Deal_democrat January 9, 2015 2:31 pm
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2015 forecast for the US economy: positive, but watch Washington and Oil

My method of forecasting is pretty simple. In fact, so simple, I call it the K.I.S.S. method. Even though the LEI is the statistic most denigrated by Wall Street forecasters, it has the inconvenient habit of being right more often than the highly-paid punditocracy, especially at turning points.

Since I'm not a highly paid Wall Street pundit, I simply rely upon the LEI for the short term, and the yield curve for the longer term with the caveat of watching out for deflation. The simple fact is, with one exception, if real M1, and real M2 (less 2.5%), are positive, and the yield curve 12 months ago was positive, the economy has always been in expansion. When real money supply is negative, and the yield curve was inverted 12 months ago, the economy has always been in contraction. The exception is that the yield curve does not help to project the economy 12-16 months later if the economy at that later date is in deflation - as it was in 1930-32 and late 2008 and early 2009.

In the few years I have also learned a lot about the methods of the late Prof. Geoffrey Moore, the founder of ECRI, so I also integrate his findings about short and long leading indicators into my forecast.

With that in mind, first let's look at the Conference Board's Index of Leading indicators, which forecasts growth about 6 to 8 months out:

 

 

This is pretty straightforwardly showing good growth in the first part of 2015.  Prof. Moore's list of Short Leading Indicators (some of which are the same as the Conference Board's, and which also look forward about 4 to 8 months out, signals the same.

Next, let's look at the second half of 2015 by first checking the yield curve:

 

 

While the spread between short term and long term treasuries has narrowed, it is still quite positive and does not forecast any problems in the next 12 months.  HOWEVER, my caveat with the yield curve is that, as in 1930-1950 and again in 2008-09, it is not effective if it occurs during a deflationary episode - which is what we are seeing now with the huge decline in Oil.

So let's look at Prof. Moore's list of Long Leading Indicators - which turn 12 or more months before the economy as a whole does.  There are 4 of these: corporate bond yields (inverted), Real M2, housing permits, and coporate profits deflated by unit labor costs.

Here are corporate bonds (red) compared with Treasury yields (red) and mortgage rates (green):

 

While all of these are moving in the right direction, they have not fallen below their 2012 lows - thus they cannot be used to rule out a recession in the next 12 months.

The story is better when it comes to housing permits (blue) which just made a new high for the economic expansion in October:

 

 

I have also included real private residential investment as a share of GDP (green).  This was highlighted by UCLA Prof. Edward Leamer as the first part of the economy that turns, on average 6 quarters before the onset of a recession.  Once again, while as of 3Q 2014 this metric was moving back in the right direction, it has not yet exceeded its expansion of of --Q 2013.

 

Next, here is YoY Real M2, from which I have subtracted 2.5%. Only when Real M2 has fallen below 2.5% has a recession occurred:

 

 

Money supply continues to signal all clear.

 

Finally, here are corporate profits deflated by unit labor costs, through the last reporting period of Q3 2014:

These made yet another all time high as of that reading.

Finally, although not included by either Leamer, Moore, or the Conference Board, I have noted that real retail sales per capita almost always turn at least 12 months before a recession.  Here they are through November:

 

No sign of any weakness here.

One last note: in 2014, a deceleration in housing's contribution to GDP was offset by an increase in governments' contributions at all levels.  Neither Federal nor state and local spending has returned to their pre-recession rates of growth, and at the state and local levels, it is likely there will be further improvement.  Possibly Washington can manage to avoid more own-goals.  If so, those are pluses for growth in 2015, which should continue to offset the impact on the broader economy of the housing slowdown of 2014.

 

In summary, when looking at the long leading indicators, all of them are moving in the right direction.  Two of them: corporate bond yields and housing as a share of GDP, are a year or more out from their best readings, and so counsel some caution.  I would like to see how housing fares in the Q4 GDP report issued later this month, but if this metric continues to move in the positive direction, then it is a safe bet that growth - including jobs and wages - will continue throughout 2015.  Depending on what happens with governments' contributions (as set forth just above), my expectation is for YoY growth in 2015 to be approximately equal to its 2014 levels.  If gas prices remain low, and housing picks up soon enough due to lower interest rates, then this may be the best year of the expansion yet.

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