The Resurrection of Risk : Part 2

Beating the Business Cycle
By Lakshman Achutha, Anirvan Banerji

(Page 2 of 3)

In September 2000, ECRI warned of a recession ahead3 to our clients, and later on the evening news shows. Few listened. Most kept upping the ante, convincing themselves and one another that any economic rough spots were only minor speed bumps. It was easy to be swept along by the enthusiasm of the New Economy.

For much of the 1990s, it was worth joining in on the fun. Contrarians missed out on the longest expansion in U.S. history, as the stock market climbed from well below 4,000 to over 11,000. Clearly, during the boom, the important question was "When is it the right time to break away from the bulls?" And in the wake of a bust, it is just as important to know when to part company with the pessimists. The bottom of an economic cycle is the perfect time to ask, "Is now the time to add to my business by buying out competitors while prices are low?"

These questions are answerable. You need not live in a constant state of fear, wondering where the economy is headed. The tools we employ to forecast recessions and recoveries for our major clients can be used by any business or individual. The objective indicators we have developed will tell you when we are approaching a turning point in the economy. We will show you how to read them and use them when making different kinds of financial decisions. But you must be strong enough to trust them - especially when they cut against the grain of popular opinion. And believe us - at the most critical times, they will.

The research that gave rise to these indicators has too long been hidden from public view. Back in the 1920s and 1930s, there was a great deal of interest in business cycles as a result of the boom of the 1920s and the Great Depression that followed. But memories fade. Most forecasters have forgotten the work of Mitchell, Burns, and Moore. This is part of the reason so many economists and financial experts were blindsided by the 2001 recession, and why much of what you read here will seem new.

In March 2001, six months after we issued our initial warning of a recession, it became clear to us that a recession was unavoidable. We were not shy about saying so. The New York Times published our call on its front page.4 In hindsight, it is agreed that was precisely when the recession began.5

We do not want to suggest that it was easy to make the call. Far from it. Over a decade had passed since our last recession call in February 1990, five months before the previous recession started. Because we are experts in business cycle forecasting and had the record to prove it, we were under enormous pressure. To make things even more stressful, this was the first recession forecast we would make without the help of Moore, who had passed away a year earlier. (Some believed that it was Moore's uncanny intuition about the direction of the economy that helped us make calls, rather than his research.) In spite of these challenges, we knew that our well-tested methods would steer us correctly. The entire ECRI staff gathered together, spending two weeks poring over each and every indicator. Only then did we steel ourselves to go public; we concluded that it would be irresponsible to do otherwise.

What led us to that conclusion? Not since the mid-1970s had the world's three largest economies - the United States, Japan, and Germany - contracted in sync. We saw that kind of synchronous contraction again in 2001. Nonetheless, for most of the year, few believed that the party was over. Confident that the economic boom would soon resume, the stock market rallied through late May - three months into the recession. Denial persisted even as corporate profits plunged and job losses mounted. In fact, cheerleaders of the boom economy continued their good-times refrain through September 10, 2001, even though stock prices had been dropping sharply since May.

By September 11, the recession was six months old. In the wake of the terrorist attacks, the confusion and the boost from emergency economic stimuli allowed some pundits to continue denying the reality of recession. Others blamed the economy's woes on the unpredictable shock of those attacks.

In the months that followed, many viewed the emerging corporate scandals at Enron, WorldCom, and Arthur Andersen, as well as the intensification of the Israeli-Palestinian conflict and the continued threat from al-Qaeda, as evidence of a "perfect storm" of freak events that caused the recession. Such a view implied that the storm would pass and things would return to the way they were. But the recession did not result from any such storm. In fact, it preceded it. Like earlier busts, it resulted from the wide gap between perceptions and reality, as the wishful thinking about an ever-expanding economy got a wake-up call from the business cycle.

The momentum of the late-1990s boom carried perceptions of growth forward, beyond the downturn that marked the onset of recession. Business managers planned for demand that suddenly vanished; individuals made important career or financial decisions based on a roaring economy; investors held on to large positions in stocks because they believed double-digit returns would continue. Few factored the risk of a recession into their plans, and when one hit with the force of a falling Acme safe, many people were left feeling like the flattened Coyote.

Why were so many caught off guard by the downturn? Certainly the cheerleaders of the New Economy were partly to blame, along with a general belief that the business cycle was dead. But the fundamental reason rests with human nature. When looking to the future, people naturally project from the recent past. Just like Wile E. Coyote, we think that because the road has been straight for some time, it will remain so.

Copyright © 2004 by Lakshman Achuthan and Anirvan Banerji.

About the Author

Lakshman Achuthan and Anirvan Banerji are the managing director and director of research at the famed Economic Cycle Research Institute. They are the trusted advisors of Fortune 500 companies, major fund managers, and government agencies throughout the world. They appear regularly on CNN's Moneyline, CNBC, and NPR, and have been featured in Money magazine and The Economist.