LAKSHMAN ACHUTHAN: Basically, you have recessions and recoveries, expansions and contractions, in the growth. And then there's another cycle, which is, perhaps, more important to the markets, which are what we call growth rate cycles. You know, I hear this every once in a while-- ah, yeah, it's kind of like the 90s, mid-90s. That's what we're doing--
ED HARRISON: Right, yes.
LAKSHMAN ACHUTHAN: --a mid-cycle adjustment. I'm like, you guys don't even know-- you have no clue what happened in the mid-90s, OK?
ED HARRISON: I'm Ed Harrison for Real Vision. I'm here with Lakshman Achuthan, who is the co-founder of ECRI, which is a principal company in terms of business cycle research. Thank you for joining us.
LAKSHMAN ACHUTHAN: Thank you for having me.
ED HARRISON: So I guess-- you know, the first thing I want to talk about-- and we were talking about this off camera before. This is a bit of a rehash because you've talked about this before. But we haven't talked about it--
LAKSHMAN ACHUTHAN: Mm-hmm.
ED HARRISON: What do you guys do that's different than what other people do in terms of understanding when a business cycle is at its peak and when it's at its bottom?
LAKSHMAN ACHUTHAN: Great question. Thank you. Basically, most macro forecasters are probably using some sort of model. They might be putting in all of the usual suspects and figuring out the correlations and then extrapolating and making a forecast for growth or for inflation or jobs or whatnot and saying, OK, here's where we are in the cycle.
Or on average, the cycle has lasted x years. So we're early or late in the cycle, whatever. Now, what we do is, number one, we just don't use models to forecast turning points because, actually, if you look at the research-- and there's actually quite a bit of research on this-- systematically, the largest errors in forecasting-- kind of like blue chip forecasting or something like that-- will occur around turning points in growth and inflation and jobs, turning points and pretty much anything simple because the models like to extrapolate. And they miss the turn. And they only see it in the view mirror. And that's why you get these surprises.
And I think the received wisdom, almost as a result, is that recessions are caused by-- it can't be us. It must be something else. They're caused by shocks. You know, it wasn't our fault. And now, we're going to put whatever the shock was into the model. And then we'll be good, right?
And you've seen that go on for a century, practically. And there keep being these surprised kind of turning points. What we do is nothing particularly new. However, the state of the art is much more advanced than people probably realize. And that is we use a leading indicator approach.
My mentor, Geoffrey Moore, was the father of leading indicators, created the first index for the United States some 60, 70 years ago. His mentor, Wesley Mitchell, actually defined what a cycle was back in-- 100 years ago or something. And these leading indicators are designed to turn ahead of the target.
So for example, let's say, you're trying to predict a turning point in production. Well, in theory, new orders could be a leading indicator of production. And it makes sense. It doesn't-- you don't have to be a rocket scientist to figure that out.
But it's a good solid basis for that idea. And then, empirically, you take a look if that's true. And maybe that's one of your inputs into a leading indicator, in this case, of some production series or production target. And we go on and on, trying to find the key drivers.
And look at them-- leading indicators in one group, coincident data in another group, the target, which people actually get confused about, lagging indicators to confirm that what you thought happened actually happened. And you can also see some long leading indicators. They have very long leads.
But they might be kind of erratic. So you have to have a sequence of indicators in order to know-- to get a good feel of where you are. Now, that's very different than a model. And everything I just described is state of the art 60, 70 years ago.
ED HARRISON: Let me ask you-- so let's see, if I get this straight. So basically, what you can do is you can say, look, here are these long leading indicators. We see things that are happening there. Let's see if they're confirmed by the short leading indicators. And then, once they are confirmed, then we can start to look at coincident and then we can start to make a call.
LAKSHMAN ACHUTHAN: Right, so what happens-- exactly. And so what happens is your degree of confidence starts to rise. And also another way of thinking about it is, if you have a turn in a long leader, when the shorter leaders start turn, up or down-- it could be up, too-- you have a prior.
So you're sitting there. A lot of people, if they're wise to it, might be looking at that. Probably not a lot-- probably a few are looking at it and wondering, is it noise or not? Again, the big issue here is signal to noise. And if you have a prior, you can start to receive something, maybe more of a signal.
And what we find, after all of this, it's not that the ideas aren't there. Markets tend to be short leading indicators. Most market prices tend to be short leading indicators. They are very good indicators.
I mean, the sources of data is also very important in this era of big data, right? You have hard data, say, the government counts something up. You have market data prices, super important, because there are signals in there that we all know.
And then you have survey data, which Geoffrey Moore was a big proponent of in the 70s. Now we start to have some history from it. But the idea that there is some information in the soft surveys is good, too.
All of that is fallible. Just like anything in your portfolio could blow up, any of these could be wrong. So you need to diversify your risk, look at all the key drivers of the cycle, which takes some experience, and then put them together in a way where you're trying to avoid as many biases as you can, one way or the other, so that you can get as clean a signal out of it as you can.
Now, the leading indicators, such as they were 60, 70 years ago, is one indicator for the overall economy. It's way too simplistic. There's manufacturing. There services. There's construction. There's trade.
There's all these different things going on. There's many cycles. And sometimes you can have a two speed economy, one kind of going up and the other going down. And on average, you model. So these kind of nuances are very, very important.
The other big thing, which I think people still struggle with today-- and I've been doing this now 20 years, professionally, and maybe a little more. And it's hard to believe, but people still struggle with the notion that there's a separate inflation cycle.
It's related to growth. But the turns in the inflation cycle can vary. There can be long and variable lags between the turns in the inflation cycle and growth. And even the same with cycles and jobs.
And so a model-- if we go back to the beginning of the discussion, a model is going to want to refer all three of those to each other, pretty explicitly. We don't make those assumptions. Yeah, they're related. We know they are, cyclically.
But there can be periods of inflation free of growth. And we nailed it in the late 90s, OK? That can happen. It broke a lot of models, all of them, pretty much.
But it was easy to describe. You can have a jobless recovery. There's no rules against that, OK? And so the indicators also showed that.
And so we have whatever knowledge and equity that we have. But we let the indicators, now about hundred of them globally, tell us a story. Is there an upturn? Is there a downturn?
And very often, at the turning points, those-- because of everything I've just described-- they can deviate. They probably will deviate from the consensus if it's driven by model.
And so the consensus will be going this way or that way. Indicators will turn this way or that way. There'll be a gap. And that has to be resolved one way or the other. And if it's a cyclical turn, it's probably going to resolve towards the direction that ECRI was looking.
ED HARRISON: Interesting, I mean, obviously, the reason that we're asking the question now-- I was telling you before-- this is part of what we would call recession watch--
LAKSHMAN ACHUTHAN: Yeah.
ED HARRISON: --this particular-- because, over the past, I would say year, maybe six months, people have been saying, is there something going on in the markets? Is there something going on in the economy that says that what could be-- what looks to be like a slow in the economy could actually turn into a recession? So we're thinking recession watch. And so we're talking to you to figure out, what do the numbers look like?
LAKSHMAN ACHUTHAN: Yeah, I would agree 100%. And to let-- to set the table here, basically, you have recessions and recoveries, expansions and contractions, and in growth. And then there's another cycle, which is, perhaps, more important to the markets, which are what we call growth rate cycles, accelerations and decelerations in growth.
And so now, we're in our fourth growth rate cycle downturn. We predicted it back in 2018 that we're having a slowdown in growth. Now, any time--
ED HARRISON: When were the other ones in this particular cycle?
LAKSHMAN ACHUTHAN: Yeah, 2010-11, downturn 2012-13, downturn in 2015-16, downturn. And then after-- in between those, you had cyclical upturns. So the last presidential election, we had a growth cycle upturn happening, following--
That actually-- it's interesting because-- I mean, now I'm getting in the weeds. But it's interesting because, earlier that summer, the summer of 2016, we had this pretty massive reflation in the leading indicators of inflation, the future inflation gauges. They just took off like a rocket.
That's a directional call, not a magnitude call. But if you remember back then, this is-- you know, it's like ancient history now, 2016. But inflation expectations were near their record low. The ten year was pretty darn low at that point.
And we had inflation-- the future inflation gauge go up not only in the US but also in Europe and in Asia. And so you had this kind of global reflation. And that was a little weird. That actually happened before the growth rate cycle upturn started to take hold.
And you know the story after that. And so we have a nice global upturn in growth, '16 into '17 into early '18. It was actually the strongest we were able to determine by the end of '16. It was going to be the strongest upturn since the recovery out of the Great Recession.
OK, so that's saying something. But then it rolled over. And we've had this global downturn.
ED HARRISON: And when things like that happen, when they roll over-- just to go back to your process-- you know, people are like, why did it roll over?
LAKSHMAN ACHUTHAN: Why.
ED HARRISON: And what's your response to those kinds of questions?
LAKSHMAN ACHUTHAN: Well, it gets into the nature of a free market oriented economy. It has ebbs and flows. It's not--
A free market, you're going to have bouts of fear and greed, run ups and downs in different components of production, interest rates, demand, debt. These are all big drivers of the cycle. At some point, prices get cheap enough and demand is pent up enough that, even though everything looks totally nasty, someone buy something.
ED HARRISON: OK.
LAKSHMAN ACHUTHAN: That's a trough. And you get a turn. And the same thing happens at the peak. When everything is very euphoric, on the margin, someone can say, you know, I've overextended.
I'm getting a little spooked. Or I'm not profitable anymore. And all of those-- those are all aspects of drivers of the economy. And then you have things like the intervention by central banks, so--
ED HARRISON: So basically, the answer that you're saying is that you're agnostic as to what the drivers are. Things just go up, and they go down. And your job is to show that that's what's going to happen.
LAKSHMAN ACHUTHAN: Well, if we've done our job right-- and I think we have. We're always trying to improve, obviously. But what I'm describing has stood the test of time.
We have some indicators, going back to the early 1900s, like 1905 or '06 or '07, right in there and space. So we have these indicators for over 22 countries, including ones that are structurally, radically different than the United States. But directionally, they're nailing the calls.
And the reason is because we're capturing the key drivers, long leaders, short leaders, in these sequences, in these many cycles, for these economies. And we are reporting the story. And sometimes--
No, we're reporting the directional call that they're making. And then we have to figure out, what's the story? I don't always know the story. You know, I'm not clairvoyant.
I don't necessarily know, oh my gosh, it absolutely was mucking around in the housing debt. I just saw the turn. Then we have to figure out what it is. Where inflation-free growth, back in the late '90s, we didn't know exactly what it was. We made the call. And then we saw it was these waves of imported disinflation from abroad and asynchronous growth around the world at that time, which is actually relevant now. Well, coming full circle to right now because we-- back in the summer, we had a European growth rate cycle upturn call.
ED HARRISON: And that's when you spoke to Raoul the last time, right?
LAKSHMAN ACHUTHAN: Yeah, yeah. Sometime in the summer.
ED HARRISON: And you've been proved right since then.
LAKSHMAN ACHUTHAN: Yeah, and it's not that the stories-- we understand all the stories in Europe and the difficulties. And maybe, as we're trying to figure out what is the story-- like you're saying, what's the story this time?
It may be as simple as they didn't put their foot on the brake, OK? The ECB never really slowed things down in sharp contrast to the Fed. And remember, long and variable lags-- the markets may react immediately to or very quickly to hints of what the Fed's doing or what the ECB is doing or whatever.
But the economy itself, those have-- long and variable lags have an impact on the economy, on the economic growth. And there's vestes juanes stuff and probably got Macron to spend some more money and some other things happened. And they went through some of their auto corrections, emissions corrections, that they had to go through.
All that's kind of run its course. Plus, they were-- they've been in a downturn for a while, so some pent up stuff. All of those things happen.
And we have less bad first happens. And then you start to get I think what we'll be on a cyclical basis, at least a sustained upturn. Now, a cyclical basis is a few quarters. I'm not saying until the end of time. They can turn down again.
What's interesting is that it's also happening in Asia ex Japan. Japan is its own story where there's a recession risk. But Asia ex Japan, including China industrial sector, is showing the cyclical upturn parts. And all of that together has given us what looks like a more constructive outlook on global industrial growth, which is not a country specific call. It's just industrial activity globally.
ED HARRISON: So basically, what you're saying is you could see, three or four months ago, that Asia ex Japan, Europe, there was a bottoming. And taken together, global manufacturing, there was a bottom. And now, we're seeing that this upturn is occurring.
LAKSHMAN ACHUTHAN: I would say in that sequence. I'd say first Europe then Asia ex Japan and then how that was giving the foundation for global industrial growth bottoming. And we have leading indicators targeted at each of those cycles, all of those cycles. And they were all feeding us and showing us to be looking at that.
And one thing that's very important-- and I just reference, again, the late 90s, asynchronous recessions-- is that it doesn't-- there's going to be, and there already has been, this conflating of those upturns with an upturn in the US. And then, if you have a stronger than expected jobs report, oh yes, definitely right. And you start to get super convinced of that. And we see that happening.
ED HARRISON: So talk to me about that, especially in the context of the jobs report, because that was a pretty nice jobs report. How would you describe it-- because we're telling one story, these guys over here this. This is what's going on. We haven't hit what's going on the US. So what is going on in the US in the context of this super nice jobs report that we got?
LAKSHMAN ACHUTHAN: Well, I think we have a slowdown, the slowdown continues. So we predicted a growth rate cycle slowdown back in 2018. That continues. It's continued through the end of this year, and it'll continue into the early part of next year. And that'll actually include a weaker performance out of the jobs market, despite Friday's number.
ED HARRISON: So jobs-- the number of jobs that are being created, non-farm payrolls in various sectors, what are they looking like?
LAKSHMAN ACHUTHAN: Well, we did a chart on kind of splitting it out, the cyclical aspect and the non-cyclical aspect. So things like education and health care-- not that discretionary. And as a result if it's not discretionary, it tends to be less cyclical.
But everything that's discretionary, that, if times are tight, I can put it off a little bit, then that's very cyclical stuff. And that's actually most-- the rest of the economy. So you could see it was a good looking jobs report.
Education and health care, I think they're around 38 or something month high in the growth rates. Everything else is around October's 99 month low in jobs growth. And so that's consistent with what our leading indicators of the employment cycle were saying, that they're saying there's still weakness there.
And that's also consistent with the unemployment rate. Now, I know the headline unemployment rate went to its record low at 3.5%. And that's driven by education and health care and overall statistics there on how the unemployment rate is calculated. But if you go into these key sectors of the economy and you do the seasonal adjustment, which the Labor Department does not-- the BLS doesn't do for you, then what you'll see is that construction sector unemployment is up almost 2%. That sounds weird, doesn't it?
ED HARRISON: Yeah.
LAKSHMAN ACHUTHAN: It's supposed to be this banging economy, right? And if anything, certainly, I would expect the construction guys