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Economic omens

We made it through 2011 without an epic global economic collapse. Phew! But will 2012 be as forgiving? Is the economy fated to recover or will it plummet into the abyss?

When searching for answers, I'll take Warren Buffett's lead and check on the trains. More specifically, rail traffic which measures the flow of raw goods (carloads) as they travel to the factory and finished goods (intermodal units) as they head to market. Strong levels of both are required before consumers can get their hands on the latest offerings and for the economy to really get moving.

As it turns out, the recent numbers from the Association of American Railroads indicate that the economy in North America is recovering, albeit slowly, from the 2008-2009 downturn.

In Canada, there were 1.2% more carloads (raw goods) and 3.3% more intermodal units (finished goods) heading out for the week ending December 10 compared with the same week last year. The numbers in the U.S. climbed 3.7% and 3.0% for carloads and intermodal units respectively over the same period. While the weekly tallies bounce around in the short term, the overall trend has been good since the start of the year and that bodes well for the economy in the near term.

You can also scour the weekly report for Canadian, U.S., and Mexican rail traffic broken down by various product lines. That way the health of various industries can be sampled. For instance, shipments of lumber and wood products in North America are up 10.5% so far this year compared to the same period last year.

The positive trend in rail traffic is mirrored by a rather different indicator from the New York Federal Reserve that I like to keep an eye on. This one is based on the spread between the yield on 10-year Treasury notes and the yield on 3-month Treasury bills which is matched up against historical data to determine the odds that a recession is looming.

Why? When 3-month yields are high compared to 10-year yields the Fed is putting on the breaks. If they go too far, a recession results. On the other hand, a large spread indicates an easing stance which is generally efficacious for the economy.

Currently the U.S. yield spread is about 1.9 percentage points, which puts the chance of a double dip recession in a year's time below 5%.

That's a mighty rosy prediction but it comes with a side order of caution. After all, the model was developed using U.S. data starting in the early 1970s. It includes some big down periods but the model may not be well calibrated for the current economic mess. For instance, debt levels are at extremes not seen since the 1930s and the situation in Europe is similarly unusual.

You can also apply the model to Canada but it should be taken with an even bigger grain of salt because it was not developed with our economy in mind. Nonetheless, currently the yield spread north of the border is about 1.2 percentage points which puts the chance of a recession in 12 months time at 5%. That's a little higher than in the U.S. but the odds against recessionary times in Canada are good.

Aside from looking at the economy, it's a smart idea to try to figure out what's on the minds of investors. Here I turn to an offbeat tool in the form of Google Trends which lets you look up the popularity of various search terms used at the website.

Just type 'recession' into Google Trends and you'll get two graphs. One tracking the number of searches for 'recession' over time and the other tracking mentions of it in the news sources followed by Google News.

As you might imagine, recession queries were generally non-existent prior to the end of 2007 but they spiked up into the downturn of 2008-2009. Since then they've been declining rather steadily until last August when they jumped up during the U.S. debt payment fiasco. As that problem passed, the trend fell again into the end of 2011 but it remains elevated compared to levels seen for much of the last 2 years.

While I'm not convinced that such searches are reliable market indicators, the trend for 'recession' might have prompted you to get out of stocks in early 2008 when it spiked sky high, which would have been fortuitous indeed.

Google Trends can also be used for all sorts of interesting back-of-the-envelope investigations and you can focus in on terms that might impact a particular industry or company. For instance, it's easy to see the growing interest in Facebook or Dollarama. One can also study the cyclical demand for 'hot chocolate' which matches up well in the winter months with 'firewood' - a connection that I intend to explore more thoroughly this holiday season.

An interesting picture emerges from these market predictors. The economic numbers generally point to better times ahead while people are still fearful. If it weren't for the problems overseas, it might be smooth sailing in 2012. But as it stands, we live in interesting times.

First published in the Globe and Mail, January 2 2012.

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