The reason this matters: The CFNAI has one of the best track records for forecasting the rate of economic activity one-quarter ahead. Over the past 35 years, the level of CFNAI has explained roughly 40% of the variation in the next quarter’s GDP. Indeed, as I’ve mentioned before, the CFNAI is one of the most important economic numbers, in my opinion.
The good news is the current reading of -0.42 isn’t indicating an imminent contraction or recession–by comparison, the reading was -2 on the eve of the financial crisis. But this week’s number does suggest that second quarter U.S. GDP growth should be around 2%. While this isn’t awful, and is in-line with the post crisis norm, it’s a long-way from the +3% growth that most economists are expecting.
It’s possible the March reading will be revised upwards in the coming months. And in any case. investors should never put too much emphasis on any one number. That said, if the March CFNAI does prove to be an early indication of a weaker-than-expected second quarter rebound, this has several implications for investors.
Market Realist – The Chicago Fed National Activity Index matters because it’s an accurate forward-looking index.
The graph above compares GDP (gross domestic product) growth figures with the CFNAI (Chicago Fed National Activity Index) over the last 20 years. It’s evident that the CFNAI dips before the GDP does. For example, the CFNAI started dipping before the GDP growth rate did during the tech bubble and the financial crisis. As a result, the CFNAI is a forward-looking estimate.
The US equity markets (VTI) (SPY) are expensive compared to global markets (ACWI). This is because the markets have already factored in a rebound in 2Q15. If the economy grows by 2% compared to the expectations of 3%, the markets will see a huge correction. A weaker economy could lead to even lower bond (AGG) (BND) yields, as investors would seek safer assets.
Read on to understand how a weaker-than-expected economy impacts the markets.