Customer Reviews

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles

5 star:		(19)
4 star:		(7)
3 star:		(4)
2 star:		(3)
1 star:		(1)

 

 

This is one of the most informative business books I have read during the past 12-18 months as Ellis shares with his reader what he learned when he set out "to investigate how I might develop an improved method for forecasting consumer spending and, with it, the rest of the economy. Furthermore, I wanted to document the basis for my forecasts with such clarity that my [Goldman Sachs] clients would understand not only the forecast but also the rationale supporting it." At this point, it is worth noting that, for eighteen consecutive years, Ellis was ranked as Wall Street's #1 retail industry analyst by Institutional Investor magazine.

As Ellis explains, his book has two broad purposes: "To help us understand and then overcome major flaws in the way most economic information is reported and digested by the business, investment, and economist communities" and "To put the this new framework to work in forecasting." The material is carefully organized and presented in four Parts:

1. "Seeing" the Economy: Creating Order from Chaos
2. Consumer Spending: The Cornerstone of the Economy and the Stock Market
3. Forcasting Consumer Spending: Understanding the Key Indicator Relationships
4. From Theory to Practice: Applying the Charting Discipline to Your Own Forecasting

Ellis then provides four appendices. It would be a disservice to him as well as to those who have not as yet read his book to comment in detail on each of the most important insights concerning, for example, the "major flaws" to which Ellis refers earlier. Rather, I wish to share three reasons why I think so highly of this book.

First, I commend Ellis on his explanation of how and why consumer spending drives the demand chain in the economy, especially in terms of the correlations between and among consumer spending, corporate profits, and the marketplace. When commenting on industrial production and the inventory effect: "The key point here is that because inventories in the retail, distributor, and factory pipelines grow during periods of strengthening consumer spending and shrink when consumer spending slows, the changes in the industrial production that supplies this system are far more volatile than the changes in consumer spending at the front end of the system." (page 75)

I also commend Ellis on his brilliant analysis of the separate but interdependent factors which can (indeed should) guide and inform forecasting consumer spending. Specifically, real income; employment and unemployment; interest rates, inflation, and the economic cycle; interest rates and the stock market; and the link between federal deficits and interest rates. When commenting on the key determinant of growth in unit consumer spending, Ellis suggests that it is "the unit purchasing power, or real wages, of the 93% to 96% of the workforce that is employed (given an unemployment rate of 4% to 7%), rather than marginal changes in the number of employed (or the unemployment rate)." Then later in Chapter Ten, Ellis explains how the real average hourly earnings series published by the Bureau of Labor Statistics "provides the measurement we need of the purchasing power of those employed." Moreover, it "serves as the single most reliable leading indicator of consumer spending and consequently also is one of the better predictors of the general direction of the economy and the stock market." (pages 117-118)

Finally, I appreciate the precision with which he explains how to calculate the macroeconomic effect of advancing or declining consumer borrowing on year-over-year consumer spending growth. Here's another brief excerpt: "In general, although borrowing clearly is affected by interest rates, it increases most when employment growth in the economy is at its strongest and consumers have the economic confidence to take on additional debt; borrowing has its most impact when job-based economic confidence is low." (page 214)

Hopefully this brief commentary will encourage many of those who read it to obtain a copy of Ahead of the Curve. Even those who have little (if any) interest in forecasting business and market cycles will nonetheless receive a wealth of valuable advice about prudent management of money. As a value-added service, Ellis provides monthly updated versions of the nineteen most important charts in this book (provided in table D-1 on page 256) at www.AheadoftheCurve-theBook.com.

I started to read this book with high expectations. I believe that a strong dose of commonsense sometimes can do more than a lot ot analytical expertise (I have a Ph.D. in Economics from MIT, and through the years I have come to recognize the limitations of hard analytical methods). The first few chapters of the book were OK. However, I was expecting the book to end with a bang, but it did end with a whimper. The author does not provide a model that can be used to forecast anything. He basically tells you to build your own. There are two possibilities:

1) You have enough technical expertise to build an econometric model of the US economy that would potentially be useful to forecast the stock market.

2) You have no analytical skills.

In case 1) you will find out that the book is basically useless, as it contains nothing new or original. The author makes a lot of noise about tracking rates of change instead of levels, but anyone who does econometrics knows he just transformed his variables so that they are stationary, a requirement for doing meaningful regressions.

In case 2) after reading the book there is nothing you can do to forecast the stock market except possibly to read the comments in Mr. Ellis web site.

The leading relationships that Mr. Ellis claims exist between variables like personal consumption expenditures and the stock market are not easy to find (assuming they exist) and the graphical tools used by Mr. Ellis are totally insufficient for the task.

Let me end quoting from the book (Appendix D, page 263):

"Those choosing to construct their own charts ... may notice some discrepancies between charts constructed from data on these Web sites and the charts in this book. This results from the "rebasing" of the statistics by the government and other bureaus that use them. As far back as the early 1980s, the elapsed time between peaks and throughs in the leading and lagging indicators was extremely clear in the years the data was reported and for five to ten years afterward. However, in following years these lead/lag times often shrunk or disappeared altogether as the data was restated and rebased by the issuing bureaus."

Joseph Ellis, gives a clear method on how to forecast business cycles...This book is NOT all about unproven theories, or fancy calculus, or econometrics, on the contrary, Joseph Ellis shows us a simple yet elegant logic on deducting casual relationships among the driving forces of the economy, which can make one filter out all the unnecessary noise and see clearly what really makes the economy thus the stock market perform....This book is a MUST READ...

as an investor and business owner for many years this is the first time i read a book that employs the kiss principle and the 20/80 rule to analyzing the economy. Economists waste so much time analyzing hundreds of statistics when really you only need to examine a handful of old true reliables. This book has the old true reliables and they are beautifully explained.

Joseph H. Ellis' ability to see ahead of the curve served his clients so well that he was ranked the #1 retail analyst by "Institutional Investor" for 18 years. In "Ahead of the Curve", Ellis presents his method for forecasting market cycles, learned and tested over 24 years at Goldman Sachs & Co., clearly and concisely so that we all might benefit. He tells us how to find meaning in the myriad of abstruse and contradictory economic indicators that we puzzle over in order to "demystify the economic cycle and the stock market's historically consistent relationship to it". Ellis doesn't ask us to believe anything that we cannot see for ourselves. All of the economic data series that he discusses are clearly charted against bear markets, recessions, and other data series, typically from 1960 to 2004. "Ahead of the Curve" offers a new, simpler, and hopefully more accurate means for business managers, analysts, and investors to predict overall market trends that can also be applied to a particular sector or company.

Joseph Ellis posits that Real Consumer Spending (PCE) is the "cornerstone of the U.S. economy", the "front end of the business cycle", and the key to understanding the economy as a whole. And he shows us why and how Real Consumer Spending leads Industrial Production, leads Capital Spending, and can predict bear markets. "Bear markets begin when growth in real consumer spending (PCE) peaks and begins to slow." Besides drawing our attention to the causal relationships of various economic indicators, Ellis points to what he believes are the "two great flaws in conventional economic analysis" that have clouded the picture and impeded understanding for too long: The emphasis on Recession, which lags the economy and the stock market and only materializes after the damage has been done. And the habit of tracking data on monthly and quarterly bases, creating a lot of "noise" and zig-zaggy charts, as opposed to tracking year-over-year percentage changes.

How to forecast consumer spending? Ellis demonstrates that real hourly wages are the key determinant of growth in consumer spending. And he shows us how the employment rate, consumer borrowing, the federal funds rate (discount rate), the federal deficit, and total domestic non-financial debt fit in the picture. Even if Joseph Ellis' forecasting methods do not prove infallible in the future, "Ahead of the Curve" provides valuable insight into the relationships between economic series based on empirical evidence. Its greatest contribution is to show us which economic indicators matter and how not to be misled by them. Ellis' thinking and his writing are impressively clear, organized, thought-provoking, and easy to follow. Updates to the many helpful charts in the book are available (free) at AheadoftheCurve-theBook.com, along with links to sources for the raw data.

I agree with the glowing reviews above. This book is a must read for anyone serious about getting the real, albeit well-guarded (or at least poorly understood) secret about using economic reports and indicators. The Ellis take? Most of them are at best coincidental or at worst serious lagging indicators and therefore of little or even negative value in warning of a bear market. Negative in that strong employment numbers, for example, give investors who follow them a dangerously comfortable sense of security while the real indicators and economy are in trouble.

That brings up another point. The vast majority of fundamental analysts and experts aim to predict recessions but as Ellis emphasizes, they are missing the boat. By the time a recession descends, about 80% of the damage to your portfolio has already been done. Is it not far more effective to develop an early warning system of impending bear markets instead? That is Joe's clear over-riding goal as it should be for all serious investors.

I am a technical analyst and trader and therefore have a bias. If a relationship or indicator cannot be proven through backtesting, turf it. My goal is to make money in the markets and any and all indicators that assist in this goal are of interest. I am now charting real average hourly earnings using the method he uses and update my chart as new data becomes available. I track an array of weekly economic reports and Ahead of the Curve has helped put then in perspective for me. It's an advanced lesson in economic analysis with methods that actually work!

I am amazed that the mainstream media have not picked up on this story, but then again maybe it is not that amazing. Anything that goes again the herd is not of interest. But those who make money in the markets know that following the herd is a great way of getting herded off a cliff. It is another unfortunate fact of life that the herd never see bear markets coming till it's too late. It never seems to fail that after an extended period of economic well-being, the herd gets lulled into a false sense of security by financial know-it-alls who say "this time its different" when crucial indicators turn negative. This is more wishful thinking than real analysis and it is too easy to fall prey to this talk, especially when everyone else agrees with you.

BTW, the book also includes a great website in which the charts are regularly updated free. The data links are also made available. Great for those who want to check back on his charts over time and watch the changes or construct their own charts.

Thanks Joe and looking forward to your next book (if there is one).

Matt Blackman - Writer/reviewer and regular contributor to SFO mag, Stocks & Commodities, Working Money, Traders Mag...

I agree, in part, with some of the glowing reviews but be careful here. In my years of technical review I know almost any chart relationship can be proved in hindsight. I recommend this book but read it with a critical view. For example, Ellis downplays the idea that money can be made by purchasing stocks on their way up to new highs, the value of new capital investment in our economy and that new products driven by investment drive consumer demand. Also, his view that deficits cause high interest rates shows a political bent that is far from a proved fact. Interest rates are in the short term a product of the Fed and in the long term one of world demand and the deficit is a secondary factor if one at all. That does not mean large deficits are good but just that their bearing on interest rates is minor.

A rate of change from the previous year in consumer spending is only measured by a few percentage points. How do we know when the peak has been reached? In a backward looking chart, that peak is fairly simple to see but today and looking forward that relationship is very difficult. Is a one point drop in the rate indicate a decline or just a small adjustment and the overall direction is still increasing? If we wait a quarter to obtain a verification, most likely it is too late.

His charts appear to show that when consumer spending is at its peak compared to the previous year, then the stock market will decline and when consumer consumption is at its low year to year point increase, the market will increase. What exactly here is a leading indicator? Again, how do we know exactly when the high or the low has been reached?

I applaud Ellis especially in the first half of his book and he has given us a gift but just read it for the value information and understand it is far from a panacea.

Don't get me wrong, the book has its merits.
It cuts through hundreds of economic indicators to select a few that make economic sense, telling a convincing story (but oversimplified). It will help mostly people with some market experience but lacking enough flying hours in macroeconomic (big-picture) thinking.

Pros :
1 - Acessible to people without an advanced degree, seeking a non-overly-technical introduction to both macroeconomics and its relation to stock market over time.
2 - Explain everything in a intuitive way
3 - Clearly tells his perspective of "how" and "why" things happen in economics, however some of the causalities he writes in the book may not be a consensus among economists or professional analysts.

Cons :
1 - Oversimplifies Inflation, foreign trade, budget deficits, the role of politics and expectations, global economics
2 - Overstates the importance of "charting" and lacks even the most basic "statistics 101" test.
3 - Macroeconomic history is a lot more complex than this book tries to show, with different monetary policy periods (keynesians in 60s and 70s - monetarists in 80s), different fiscal policies ("anomalies" in the book), productivity growth, shocks, demographics, wars, etc.
How stock market reacts to economic changes is also not that simple and may confuse even smart (but naive) guys who may think they understood a lot of macro-thinking after reading this book..

Bottom line : Book does not add too much to those already in the field. It's a very good introduction to an average investor seeking more macroeconomic knowledge (big-picture investing), but be *very careful* with oversimplification of economic history, hidden unstable relations between variables and not-that-simple theoretical subjects;

Excellent analysis & description of sequence of events in economic cycle & their impact on stock market. Commonsense, visual explanation of which macro variables lead & which lag, thus helping investors focus on what's important during each phase of the economic & market cycle. Rightly puts focus on when market damage is done, not when NBER declares recession. Must read for serious students of economy & market.

This book by Joseph Ellis is an interesting read about various business and market cycles. For traders and investors, the most important information concerns the impact of "real personal consumption expenditures" (PCE) (inflation adjusted) on the economy and the markets. Most economists and most stock market analysts believe there are very few, if any, leading indicators that `predict' where the economy and the stock market will head. That may be true, but, one would be amiss not to pay attention to the increase/decrease of PCE and it's apparent impact on the economy and the markets. It certainly appears that historically, the PCE has been a good leading indicator of where the markets will be heading.

Even more importantly, any business owner or corporate executive who doesn't consider what is happening to the PCE is setting himself and his company up for a nasty fall. Ellis also talks about numerous other indicators (interest rates, unemployment, inflation and the like) and shows how they are all 'trailing' indicators of what the economy has done, not a leading indicator of what it will likely do based on personal spending.

This book should be read by any business person who is concerned for how the economy is doing and the impact it might have on his business. Investors should read it to understand how PCE can give excellent preliminary alerts to changes in the economy and the markets. It should be required reading for business students in college.