State Coincidence Indicator
Overview
The State Coincidence Index (SCI) is an economic recession indicator. The SCI is a combined index score published by the Federal Reserve Bank of Philadelphia to approximate the health of each US state. By simply tracking how many of the 50 states are experiencing a month-over-month decrease in their SCI, we can create a model to approximate the likelihood that the aggregate US economy is also shrinking and heading into recession. Since these index scores are usually available several months prior to NBER's GDP data (and therefore ahead of NBER's declaration of an official recession), this could be a useful signal, given typical market performance during recessions.
The below chart shows the number of US states with a month-over-month reduction in these SCI scores. The average over the dataset shows that, on any given month, about 9 states experience declining SCI's. The average number on the first month of a recession is about 26 states. As of October 1, 2023, there are currently 32 states with a decreasing SCI, indicating a High risk of an upcoming recession. The chart below shows these values over time, as well as the average and +/- standard deviation bands.
This model was originally developed in a paper by Kevin Kliesen and Cassandra Marks at the Federal Reserve Bank of St. Louis.
Looking at Standard Deviations
In line with other market models covered on this site, it's interesting to look at the current data in terms of the historical norm and standard deviations from that norm.
It should be noted that this methodology is illustrative only. Statistically, this data doesn't follow a standard distribution and is bounded by the 0-50 range (as it's simply a count of US states). In other words, there is a zero percent chance that 51 states will ever have a negative month-over-month SCI growth rate.
On average, there are 8.97 states with a negative coincidence index. The standard deviation is 11.94. Again, since it's impossible for fewer than 0 states to have shrinking SCI values, the standard deviation analysis here is somewhat nonsensical. That said, for modeling purposes, we consider a value of 0 to represent "low" risk of an upcoming recession.
Theory & Data
The Federal Reserve Bank of Philadelphia publishes State Coincident Indexes for each U.S. state every month. These indexes are a summary statistic representing four main variables:
- Nonfarm payroll employment
- Average hours worked in manufacturing by production workers
- Unemployment rate
- Inflation-adjusted wage and salary disbursements
The link above provides additional data on the history, methodology, and data sources used to construct the index scores. Ultimately, the SCI number for each state is a reflection of the current economic conditions. A rising SCI signals an expanding state economy, while a shrinking SCI indicates a contracting state economy. Since the aggregate U.S. economy is simply the sum of all 50 state economies, this data should serve as a good indicator of the overall national economic conditions.
Predicting Recessions
The model charted above is quite straightforward: by counting the number of states each month with a shrinking economy (i.e., those with a month-over-month declining SCI value), we can forecast the likelihood of an upcoming or current recession. As clearly seen in the chart, each national recession since SCI data became available in 1980 was preceded by a significant increase in the number of states with declining SCIs. There are very few false positives in the dataset. The only exception is in January 2003, when over half the states had declining SCIs, but the U.S. managed to avoid a recession.
Official Recessions
US economic recessions are officially declared by the National Bureau of Economic Research (NBER). While it is commonly said that a recession is defined as two consecutive quarters of declining GDP, NBER does not use this strict definition. According to NBER, a recession is:
"A significant decline in economic activity that is spread across the economy and lasts more than a few months." The NBER committee views three criteria—depth, diffusion, and duration—as necessary, where extreme conditions in one criterion may offset weaker indications from another.
Additionally, NBER does not declare the beginning or end of a recession until 3-6 months after it has occurred, making the official declaration essentially irrelevant as a tool for understanding the current state of the economy. Real-time indicators are far more useful for assessing the situation.
Predictive Value of the Model
The SCI model excels at predicting national recessions, as evidenced by the chart above. Every U.S. recession has been preceded by a spike in the number of states with shrinking SCIs, with an average of 26 states contracting in the month the recession begins.
The real question, however, is whether this information is useful in predicting future stock market returns. The answer is no, not really. Even though we know the stock market tends to drop during recessions, the market's behavior isn't predictable enough to create a trading strategy. While the first month of recessions typically sees negative stock market returns, there isn't enough consistent data to build a reliable strategy. If such a strategy were possible, it would likely have been exploited and arbitraged away by now.
