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The omens - well, some of them - look good for 2012

The global economy made it through 2011 despite Europe's debt problems, high unemployment in the United States and growing worries about China's red-hot housing market. But will 2012 be as forgiving?

Opinions abound, of course. But three indicators suggest the outlook may be brighter than is generally thought.

The first is North American rail traffic. Warren Buffett has paid close attention to train statistics for years, because rail traffic provides an objective measure of the flow of raw goods (carloads) to the factory and finished goods (intermodal units) to market. Strong levels of both are required for the economy to really get moving.

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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-per-cent more carloads and 3.3-per-cent more intermodal units heading out for the week ending Dec. 10 compared with the same week last year. The numbers in the U.S. climbed 3.7 per cent for carloads and 3.0 per cent for intermodal units over the same period. While the weekly tallies bounce around, the overall trend has been good since the start of 2011 and that bodes well for the economy in the near term.

The positive trend in rail traffic is mirrored by a different indicator from the New York Federal Reserve. This one is based on subtracting the yield on three-month Treasury bills from the yield on 10-year Treasury notes.

When the spread between three-month yields and 10-year yields is narrow or even negative (which happens when the three-month yield is higher than the 10-year yield) the Fed is slamming on the brakes by making it relatively expensive to borrow money in the short term. If the Fed goes too far, a recession results. On the other hand, a large spread between three-month T-bills and 10-year bonds indicates the central bank is easing by making short-term loans cheap in comparison to long-term debt, which is generally good news for the economy.

Right now the U.S. yield spread is about 1.9 percentage points. Based upon similar readings in the past, the chance of a recession in a year's time is below 5 per cent.

That's a mighty rosy prediction but it comes with a side order of caution. The model was developed using U.S. data starting in the early 1970s. The model may not be well calibrated for the current economic mess. Debt levels are at extremes not seen since the 1930s and the situation in Europe is similarly unusual.

How this situation resolves itself hinges in large part on the psychology of consumers and investors, so it's a smart idea to try to figure out what's on their minds. Google Trends provides an easy way to do this, by letting you look up the popularity of various search terms.

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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.

Recession queries were generally non-existent prior to the end of 2007 but they spiked during downturn of 2008-2009. Since then they declined steadily until last August when they jumped during the U.S. debt payment fiasco. As that problem passed, the trend fell again toward the end of 2011, although it remains elevated compared to levels seen for much of the last two years.

It's not clear that such searches are always reliable market indicators, but they have been timely alarms of late. For instance, the rising trend for "recession" searches might have prompted you to get out of stocks in early 2008.

An interesting picture emerges from these market predictors. At least for now, they point to decent times ahead. But well-informed investors should keep an eye on all three as we turn the calendar to 2012.



Special to The Globe and Mail

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About the Author

Norman Rothery, Ph.D., CFA, is the founder of StingyInvestor.com and has been catering to value investors since 1995. He publishes the Rothery Report, a value stock newsletter. Norm obtained a Ph.D. in atomic physics from York University before following his passion for investing. More

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