LAKSHMAN ACHUTHAN: That one true international cycle is with industrial production growth. A resolution of the trade war today would not remove the cyclical downturn. US IP is already flashing a recessionary yellow flag. And you've got this wave of these disinflationary impulses still coming.

RAOUL PAL: The first person who wants to test my recession idea is Lakshman from ECRI. Now, why Lakshman? It's because we speak the same language. We come slightly different ways, but he looks at business cycles, and I want to get a read from him, whether his key leading indicators are rolling over and indicating recession, and whether he syncs with concerning signs or not. It may be that he disagrees with me, and this is what I want to find out. These are the key things we need to know.

Lakshman. Good to get you back. You were one of the first people in my mind when I thought, okay, I want to test out this hypothesis, because we both use business cycles. And I've even switched to ECRI data now as opposed to ISM because I actually found it more reliable. I really wanted to pick your mind about this recession topic. And I think I've seen some of the things that you've talked about that you're not entirely sure either, whether it gets any worse from here, but I just want to get it from you afresh what you're thinking and some of the areas that you're digging into on this.

LAKSHMAN ACHUTHAN: Right now, the bottom line is that we're continuing in an ongoing growth rate cycle downturn. So, it's a cyclical downturn, it's not a flash in the pan, it's going to persist. It's pervasive, it's pronounced, become more pronounced. That all is happening. And it has yet to run its course, we don't see an end to that slowdown in sight. Now, necessarily, every time you begin a growth rate cycle downturn, a deceleration in growth, your risk of recession comes on to the table, it's an active risk.

Now, that's in contrast to when you're in a growth rate cycle upturn. When you're in a growth rate cycle upturn, recession is off the table, it's just not there. When you're in a growth rate cycle downturn, now, you have to really have your feelers out and say, what's going on with recession risk?

So, we made this growth rate cycle downturn call last year. The growth rate cycle is decelerating in terms of output, and income, and sales, and jobs even. And I think that's becoming more and more apparent. I'd say many people who had denied that growth rate cycle downturn really came to it with a lot of vigor at the end of last year. And they went, whoa, not only is it as a slowdown, it's a recession practically. That's what they priced in now. We didn't see that. And we hadn't called for a recession at that point, continued growth rate cycle downturn.

Now, you then have the Powell pivot. And I think people just flipped and went to the other side of the boat practically and said, okay, recession is off the table. And now, there's a re-acceleration in growth, we're going to re-accelerate the proverbial second half rebound, was priced in pretty quickly. Nope. These indicators, the cyclical indicators are steady as she goes. There is a growth rate cycle downturn that is continuing. That call remains intact, and I think is being proven out actually by the incoming data. We are seeing a continued deceleration in overall economic activity.

And the way I would sum that up vis a vis like, is there a recession somewhere on the horizon? Is that we're slow walking toward a cyclical window of vulnerability? Now, many people think recession is the result of some shock. Somebody did something wrong, or something happened that nobody could have predicted. And that's why there was this recession, some negative shock. And that's not how recessions are made. We've been studying this for longer than I care to admit.

And the crux of our finding is that there's an endogenous cycle, which is being tracked by good cycle indicators, including leading indicators, which can tell you if you're in a downturn or an uptrend. Now, we're in a downturn, and we're looking at the forward and leading indicators to see how that downturn is likely to progress. If we begin to see a window of vulnerability opening up, which would mean that our indicators are falling in a much more pronounced pervasive and persistent way than they are currently, then virtually, any negative shock, any of the things that have occurred over the last half a year can become a recessionary shock.

And so, when we say in our parlance, we're slow walking towards a window of vulnerability, I think that's a very active thing that we have to keep in mind. So, when our indicators indicate the window of vulnerability has opened up, that's when we'll make- if and when that happens, that's when like a recession call. Hasn't happened while we're sitting here today. Plenty of yellow flags for us to talk about during our discussion now that do have us worried on in that regard. And I'd be happy to get into those if you want.

RAOUL PAL: Yeah, because I'm looking at different things. But look, with both of the business cycle. I'm seeing similar. I'm not seeing yet really pronounced slowdowns anywhere, I'm seeing the same weakness, and it looks like in some countries, that looks quite negative. So, Germany, for example, and the US, not hundred percent clear yet, but it's edging towards zero GDP growth- doesn't mean a recession as we know. But there are some things like semiconductor sales, one that are really in freefall.

The certain things are in freefall, anything with transport, shipping and world trade. I think you've been talking about world trade as well- that are interesting. But we had world trade in freefall in 2015 and we didn't get a recession. So, these are what I'm struggling with. So, I'd love to hear where you're seeing any particular vulnerability or things you're saying, actually, this is much stronger than we would imagine.

LAKSHMAN ACHUTHAN: Sure. So, when I hear what you're saying about manufacturing, say, Germany, semiconductors and those soft spots, the way that I received that is that all falls very much in line with global industrial growth. Now, when we look at global growth, the one true international cycle is with industrial production growth. So, the manufacturing side, we're all making parts of each other's end products, or different part on the supply chain.

And so, that is the truly linked international cycle. It's hard to have linked cycles and services or in construction, for example. But you can really have it in the industrial sector, and then you see it manifest there. So, I agree with you. In Europe, the industrial sector, quite weak. Think in the US, the industrial sector is quite weak. In fact, that would be one of the yellow flags- recessionary yellow flags that I would throw out there is IP growth. That doesn't look so great. It's starting to look closer to a recessionary reading. Okay, and that is one of many indicators that would be watched in a recessionary situation.

All of this is linked to the global industrial cyclical downturn that we predicted at the end of 2017 based on leading indicators. And the reason I'm bothering to be so specific with these dates is because the global PMI peaked at the beginning of '18. People started to see that in the rearview mirror in early '18, conflated it with the beginning of the trade war rhetoric, and blame the cyclical downturn on the trade war itself. That's not how we got here. The way we got here is an endogenous cyclical downturn in global growth that happens when you're in a free market economy, and it happened.

And on top of that, I'm not saying the trade wars helped. It's made things more negative. But that came second. So, the implication that I would propose is that a resolution of the trade war today would not remove the cyclical downturn. And I think there's a presumption that it would.

RAOUL PAL: That's why the market wants to trade this news.

LAKSHMAN ACHUTHAN: Yeah. And they're salient. Oh, this happened with somebody said this, somebody said that. I can only act on it. But in actuality, the world we live in is a free market economy dominated by free market activity, and fund flows and business flows and all this stuff. And that stuff is inherently cyclical. In particular, when you go to the industrial sector that has the bigger cycle than the other sectors.

And so, I think the weak spot in Germany, as you say, in Europe, in the United States, is around the manufacturing sector. There's one other nuance here that's different is that in this decade, as we all know, US energy production has really ramped up. It is what it is. It's good thing. I'm not saying it's bad thing. But what it introduces is this notion that typically, we think of high oil prices could be a negative shock. Well, in the current configuration, given the change in the structure of the US economy, low energy prices can be a shock. Yeah, that could be a negative shock here, may actually overwhelm what we used to think it was like, so-

RAOUL PAL: Because we used to think it's a consumer thing. That's industrial production thing.

LAKSHMAN ACHUTHAN: Yeah. So, that center of the country has been really doing well. And in fact, I brought a chart on that, which relates to what's going on with industrial, sensitive industrial materials prices. And just a quick sidebar here, we love cycles. We, back in the '80s, developed a Sensitive Industrial Materials Price Index. It's very different than other commodity indexes.

RAOUL PAL: Is this the JOC one?

LAKSHMAN ACHUTHAN: Yes.

RAOUL PAL: It's just brilliant. And I now can't get it for free on Bloomberg. I used it for years.

LAKSHMAN ACHUTHAN: I can give it to you. I can give it to you. It's the ECRI IPI now. We just renamed it. But this is- to the journal of commerce back in the '80s. And it actually, when we were putting together the weekly leading index, we needed a good Commodity Index to put in there. And we created the JOC to do that, Dr. Moore did.

Now, every single component- there's about 19 or so in there, is hypersensitive to cyclical moves and industrial activity. A feature of the JOC, through the IPI, is that about half of those components are exchange traded and half are not. So, there are these moments where speculative forces can do a temporary lift on commodity prices.

There's a supply disruption or a Powell pivot, these things can lift commodity prices and oil for that matter, and they did. You saw that last year with oil, you saw it at the beginning of this year with the risk on trade, but the non-exchange traded components of the JOC Index, the IPI, just keep going down.

RAOUL PAL: It's pure supply and demand.

LAKSHMAN ACHUTHAN: And so, on that demand side, which is where we can really have the insight, this thing's still cycling down, it's not over. So, that is pulling down on oil prices, even though they'll be these temporary- maybe today, they lifted a little bit, somebody said something but that ultimate what's going on with demand growth is anchoring those tradable commodity price inflation.

This is totally in line with our global leading manufacturing index which leads to that price inflation, which is still cycling down. We look abroad. China is a big player here. There's a lot going on in China, but one thing of particular note is that their industrial cycle, leading indicator of their industrial production growth is still going down. So, you get the theme here.

And the theme is very in line with the sentiments that you were raising at the beginning of our talk. And so here, we'll put a chart up for everybody to see, but you have the non-exchange traded components of the IPI index. You see oil prices can deviate here and there, but they can't get away from it. They get pulled right back down to-

RAOUL PAL: So, it's the core trend of commodity prices essentially.

LAKSHMAN ACHUTHAN: Yeah. And it's things that are tough to speculate in like tallow, or burlap. It's tough to get, to put up, probably nothing here do it.

RAOUL PAL: Probably leather is on there as well.

LAKSHMAN ACHUTHAN: Yeah, you can do it. But you have to get a little creative, and not as easily as just trading oil or copper. Now, what's interesting, and to the point of the double edged sword on the US economy and actual economic activity, is you can see the relationship with rig counts. Sure, when things go up, rig counts are blowing through the roof. And now, the cyclical downturn, that's a very, very, very clear decline in rig counts and that's depressing activity.

RAOUL PAL: [Inaudible] with this, because you think in the same way I do, we think of rates of change. So, you've got a rig count, it's gone from 160 to zero, nobody else would have noticed it because they'll have said, well, the rig counts are going up.

LAKSHMAN ACHUTHAN: They're pretty high. I was just looking at someone yesterday who was saying, oh, big truck sales were pretty good. They're at pretty high levels. So, rate of change got cut in half. So, that really catches my eye. And that's where the interesting thing happens- is at the inflection point of the rate of change, both at the top and the bottom. And I think we have another one of our big calls has been- and I think we share this view is that the inflation cycle rollover.

And so, in making that call last summer, we have a lot of bond clients, and they're like, whoa, seriously, out of consensus. This is going to be a big deal to move this through the committees. And that's what it was saying. And you had the consensus view, like, I'll pick on Jamie Dimon, because why not? He was saying it's going to go- in the fall, he's saying it's going to go to 4% or 5%. Get ready for that. And it topped out at 3.25% in October and November. And you know the story.

RAOUL PAL: The signs of this reversing, I thought, was a deflationary trend in place by March of last year.

LAKSHMAN ACHUTHAN: No, no, I agree.

RAOUL PAL: The market don't want to say it.

LAKSHMAN ACHUTHAN: No, no, no. So, there are leading indicators that future inflation gauge actually peaked in February. But we have a whole process. So, we're saying, okay, it's a pronounced pervasive, persistent decline. So, we can see these things coming. But the objective call, not reading my view into it, was clear to us by the summer, and then very officially, September, beginning of September, make that call.

And it's not over. Everybody got happy to- I don't know who, but some people got happy on Friday. And they said, oh, this is great. The economy is booming, and whatever. Future inflation gauge went down to a new 3-year low on Friday. So, this is not over. The elephant in the room has been for some time and remains the inflation cycle downturn. It's just sitting right there. And nobody wants to talk about it.

And I think it's this level and rate of change thing. Services, inflation is up here, it's pretty high. What are you talking about? Or some other inflation is right here, this level is high. It's not about the level of it, it's about the direction of it. And that's what's being missed. But I think the Fed is having to pay some attention to that, because the bond market's forcing them to.

RAOUL PAL: So, when you're looking at the forward looking indicators, how far forward your leading indicators, how far do you think they lead? What is the average [inaudible]?

LAKSHMAN ACHUTHAN: I'd say a couple of quarters, a quarter or two, it depends. A long leading indicator can have a lead on a specific economy of several quarters. Our very longest leading indicator, which is something we call the GIGLLI, and we have a lot of acronyms, fun with acronyms. But this is the Global Industrial Growth Long Leading Index. And this is for 21 economies. We strip out the long leading indicators for those 21 economies that we monitor, we strip out the components that are related to the manufacturing sector. And we look at a diffusion index of those inputs. And that has a lead of about a year over IP gross globally.

It's prone to a couple of false signals and very long leads. So, we have to have short leading indicators to tune that up. So, we get a heads up. But you can't necessarily act on any of these because they're so far ahead, but it gets you ready and gets you thinking.

RAOUL PAL: That's right, you're looking for signals.

LAKSHMAN ACHUTHAN: So, we will then see things happen in our shorter leading indicators that lead by a couple of quarters, and we're ready to receive it as a signal as opposed to noise. And then it'll come in, you'll see it in the PMIs or the JOC rate of inflation, and then it'll finally land up on IP. And so, we can see it develop, and you can develop your conviction levels along the way as that occurs.

So, that's why we like things in sequence- long, short, very short, coincident, that's one thing to look at. And then we like broad arrays of indicators. So, it's not only manufacturing, but it's also services or construction or trade, to get a feel, sometimes we can get to speed economies, where say, in '15-'16, it was really as manufacturing impetus to the downside and other elements of the economy are holding up.

RAOUL PAL: Are you seeing evidence of that now? Are you seeing pretty much everything confirming the pervasive downward trend or slowing of growth trend?

LAKSHMAN ACHUTHAN: Well, we've had upticks in a slew of our leading indicators away from manufacturing, driven almost entirely by market related inputs. So, in our leading indicators or forward indicators, there's basically conceptually three buckets. You have market-related data and derivatives to that. You have private survey data. Then you have hard government data.

And for us to make a turning point call down or up, it needs to be a pronounced upturn relative to past upturns, persistent and pervasive, all, it has to have the majority of the inputs contributing. The reason we know that these little upticks that we've seen are insufficient to make an upturn call or a so-called soft landing call or whatever, is that it's all then in the market-related stuff.

RAOU