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The Recession Buy Indicator

Sunday, May 18, 2008 | 09:00 AM

Interesting piece by Mark Hulbert in the Sunday NYT on the Recession Buy Indicator. This timing signal was created by Norman Fosback author in the mid-1970s of the popular investment textbook “Stock Market Logic.” The book, though out of print, was first published in 1976, and has gone through 18 printings, selling more than a half-million copies (used copies are available at Amazon and elsewhere).

The indicator goes something like this:

"The [ Recession Buy Indicator] focuses on the four business barometers that together make up the federal government’s index of coincident economic indicators. These four focus on industrial production, manufacturing & trade sales, nonfarm payrolls and personal income. The Recession Buy Indicator is triggered when — as is the case today — each of these four gauges is below its level of six months earlier. On such occasions, Mr. Fosback considers the economy to be in a recession or very close to it."

I love this sort of approach, for several reasons: It is a contrarian play, which has tremendous appeal to me; it provides an objective, mathematical way to make a buy or sell decision; it has a significant body of backtesting.

Since creating the indicator in 1979, it has triggered 4 buy signals. Over the 12 months following, NYSE average gains were 37%, and after 3 years, 106% (triple the stock market’s average).

Before you mortgage the house to buy long dated index calls, however, there are a few caveats worth noting. The previous signal was in February 2001 -- 18 months before 2000-2 bear market lows. Buyers of that signal got crushed in the ensuing selloff.

That sort of miss is the reason Ned Davis Research is less of a fan. While the average performance of the indicator was very good, the misses are enough to caution not blindly following the signal. And, during some recessions, the stock market’s actual bottom came much later.

"That is one reason, he said, that his firm doesn’t mechanically issue a buy signal six months after the economy begins to turn downward. Instead, it prefers to await confirmation from a number of its other indicators that a bottom has been formed. In the current market, that confirmation has not yet come, he said, and his firm has a policy of not trying to predict when it will."

Hulbert's use of data and statistics is why he is always an interesting read . . . Good stuff.

UPDATE: May 18, 2008 10:23am

Alternate views can be seen here and here .

Sources:
An Alarm Is Blaring: Time to Buy
Mark Hulbert
NYT, May 18, 2008
http://www.nytimes.com/2008/05/18/business/yourmoney/18stra.html

Stock Market Logic a Sophisticated Approach to Profits on Wall Street
Norman Fosback
Hardcover: 384 pages
Publisher: Inst for Econometric Research (1976)