As explained in an earlier post, I am sceptical of US recession forecasts. One indicator I am monitoring closely is weekly initial claims for unemployment benefit. Claims always rise sharply at the onset of recessions – see chart. Indeed they usually start moving ahead of cyclical turning points, which is why they are included as a component of the Conference Board’s index of leading indicators.

Claims rose a bit during August but have since fallen back, with the latest figure the lowest since May. A five-week moving average is essentially unchanged from a year ago. Further evidence of labour market resilience comes from daily data on withheld income and employment taxes. Receipts per day so far in September are 7.7% up on a year ago – slightly above the 6.8% average increase over January-August.

So far so good.

Changes in equity analysts’ estimates are a good guide to corporate earnings momentum. September figures are reasonably encouraging – upgrades and downgrades across developed markets broadly balanced out.

The details show expected large downgrades among financial stocks, reflecting the “credit crunch”. However, there has been offsetting strength in other areas, including IT, telecommunications, materials and industrials.

As the chart shows, G7 industrial activity correlates with the world revisions ratio – upgrades minus downgrades divided by the total number of estimates. The ratio fell back in September but remains at a level consistent with economic expansion.

“Every dog has his day” – even the dismal Japanese stock market. The TOPIX index is again languishing at the bottom of league tables, having fallen 8% so far this year against an average rise of 7% in other major markets (as measured by the MSCI World ex Japan index). Four factors hint at better performance. First, the latest Ministry of Finance business survey was solid, suggesting the economy is bouncing back from early summer weakness – see chart. Second, corporate earnings continue to outpace expectations: analyst upgrades have outpaced downgrades in each of the last three months. Third, the liquidity backdrop has improved, with inflation-adjusted broad money recently growing faster than industrial output, having lagged in 2006. Finally, investor sentiment is depressed – arguably a precondition of a turnaround. According to Merrill Lynch’s global fund manager survey, pessimists on Japan now outnumber optimists for the first time since 2003.

The euro’s surge against the US dollar and sterling partly reflects a view that the Eurozone economy will “decouple” from expected US and UK weakness. Interesting then that the latest business surveys convey exactly the opposite message. While the US Philadelphia Fed and UK CBI manufacturing surveys remained upbeat in September, Eurozone purchasing managers have become markedly more bearish. Complacent ECB officials may soon suffer a rude awakening.

Mostly for fun, in 2002 we calculated a “three bears forecast” for the FTSE 100 index based on the average performance of UK stocks during and after the three largest bear markets of the last century: 1929-32, 1936-40 and 1972-74. Much to our surprise, the “forecast” has proved a remarkably accurate guide to the broad trend in the market – see chart.

Significant deviations from the forecast path have represented buying or selling opportunities. For example, the FTSE overshot the three bears by 10% in April 2006 but subsequently corrected sharply to close the gap.

At the recent August low the FTSE was 13% below the forecast – the largest downside deviation since the current bull run started in 2003. This appears to have been another buying opportunity, with the three bears suggesting the index will return to 6700-6800 later this year.

Simplistic historical comparisons are bound to break down at some point but the economic, liquidity and sentiment backdrop still seems consistent with higher prices.

The Federal Open Market Committee’s decision to lower the Fed funds and discount rates by 50 b.p. represents a bold attempt to forestall the negative economic impact of recent financial market dislocation. Visibility is low and there is a risk that the Fed has jumped the gun – current economic indicators remain consistent with expansion and market stresses were starting to abate before the surprise move. The consensus is convinced that further cuts will follow but a scenario of “one and done” should not be ruled out. Remember August 2005 in the UK?