The investment team members at Pinnacle are connoisseurs of investment research. We read a vast variety of analysts and money managers, each having their own opinion about the economic cycle or their particular area of expertise. We have spent a decade finding those analysts who are clear in presenting their point of view, are well-known in the buy-side investment community, and are (hopefully) smarter than we are. However, as we have opined on many occasions, it is simply not possible to be in the business of venturing opinions about the financial markets without being wrong at one time or another. For that reason, most analysts make certain they caveat their thoughts about financial issues and at least make an effort to present the opposing view, if for no other reason that they don’t want to make a devastating mistake that could upset their reputation and their business. Everyone involved knows how to play this game. For Pinnacle, as the consumer who is willing to pay for the privilege of reading an analyst opinion, we subscribe to analysts and research firms that give the clearest possible forecast. We know how to sift through all of these opinions and add them to our own internal research as part of the “weight of the evidence” we use to formulate Pinnacle’s own investment view. If the analyst or research house we follow is too vague they inevitably get dropped from our research. And if they are clear and concise we applaud them, but also require that they are right more than they are wrong.
In our business, the consequences of an analyst making a major call and getting it wrong are enormous. We like to talk about the “water cooler conversations” that must take place when a research firm is on the wrong side of the market. We can imagine the hushed tones and concerned whispers as the research firm (or money management) firm junior analysts huddle around the water cooler and wonder when or if the “boss” is going to reverse his or her position if the market persists in going against them. In today’s market environment, money moves so quickly that the economic risks of a blown call are real and immediate. To stick to a position that is going against you is either the height of folly or extremely courageous. However, it is only in hindsight that you know which one it is. All of which brings us to what we imagine are the most urgent water cooler conversations going on over the past several months. Let us introduce you to ECRI.
The Economic Cycle Research Institute (ECRI) is a private economic forecasting firm. It was founded by Geoffrey Moore, an economist who constructed one of the first leading economic indicators in order to try to get an early read on the twists and turns in the business cycle that naturally occur. ECRI has developed a strong reputation by building an impressive longer-term track record of accurately calling turning points in the business cycle; usually well ahead of the consensus. They are considered “the best of the best” and if you want to hire them for their highest level of service it will cost you as much as $300,000 per year to hear what they have to say. To say they are widely followed by the Wall Street is an understatement, and their current leader, Lakshman Achuthan, might be one of the most influential analysts that you have never heard of.
Unfortunately, recently ECRI has been embroiled in controversy due to their most recent call that the U.S. economy has likely entered a new recession. They actually first made this call just about a year ago, early in the fourth quarter of 2011. At the time, they estimated that it should become evident that the U.S. has entered a new recession by midway through 2012, if not sooner. Mr. Achuthan is quoted in a New York Times article from last October 8 (“An Ugly Forecast That’s Been Right Before”) as saying, “We’ve entered a vicious cycle, and it’s too late: a recession can’t be averted.” As you might imagine, this is the kind of statement that crosses the usual line of caveated forecasts and finds itself highlighted in the “we better be right” conversations around the water cooler.
The group is now being criticized because official statistics do not support their claim. In fact, the official GDP growth rates for this year were 2% in the first quarter, and 1.3% in the second quarter. While certainly subpar, the rates of growth are nonetheless positive, therefore not meeting the common definition of a recession of two consecutive quarters of negative growth. (Note: ECRI and others point out that the actual definition of a recession does not require two consecutive quarters of negative GDP growth.) Looking ahead, the Bloomberg median estimate from 74 economists for GDP growth through the end of the year is for continued low, but positive growth – they’re expecting 1.8% for Q3 and 2% for Q4, respectively.
For their part, ECRI is not backing off of their call. Mr. Achuthan has repeatedly returned to the airwaves to defend their viewpoint, arguing that past recessions were not widely recognized until well after they had begun, largely because of widespread revisions to economic statistics that tend to occur around turning points in the cycle. As a result, they believe it is quite likely that the official data could be revised later to show negative readings, instead of their current low positive readings. He has also asserted that people are drawing incorrect conclusions from one of their proprietary indicators that they’ve made public. ECRI’s Weekly Leading Index, which has risen over the past few weeks, apparently is not sending the positive signal that outside observers seem to be interpreting from it, according to Mr. Achuthan.
The bottom line is that the water cooler conversation must be buzzing at ECRI. As an organization ECRI is far too professional to officially be anything other than agnostic about market cycles in general, and they will continue to report the evidence as they see it in support of their current view regardless of the current market consensus. But around the water cooler, in the most hushed tones, staffers must be hoping for the consensus to be wrong and for the U.S. to fall off of the fiscal cliff at the end of the year…. and into recession early in 2013.
Authors: Carl Noble, Senior Investment Analyst, and Ken Solow, Chief Investment Officer