Drawdown Analysis Is Also Valuable For Economic Indicators

The caveat is that the chart above is based on revised data. In real time, releases of economic numbers are first approximations that may or may not be reliable and so additional confirmation is required in second- and third-month updates following an apparent trough.

In the example above from 2020, once a second month of rebound was confirmed (via the release of June data), the case strengthened that the slide in payrolls was over. Note that the June employment report was published in early July. Having solid econometric support for thinking that the worst for the labor market had passed at that point was still timely, given the generally pessimistic views that prevailed at that point.

Another useful feature of economic DD data is that there are relatively few false warnings vs. financial markets. When DD for payrolls goes negative, it tends to stay negative until a trough is reached and a rebound starts. Something similar applies to other econ data sets. It’s not 100%, but this aspect is far more common vs. the relatively chaotic start-stop DD trends that predominate in financial markets.

As a result, there’s opportunity for estimating the start of potentially severe DDs in economic data early on, which can provide warnings of economic trouble ahead of the usual suspects.

In future posts, I’ll formalize how to run DD analytics for multiple indicators and combine the signals as an alternative metric for monitoring business cycle risk.

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Disclosures: None.

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