The Conference Board released the most recent data on the U.S. Leading Economic Indicator. This is probably one of those economic indicators that you may see the headline or read the news story but not truly understand what the index is, how it is constructed or what it is intended to accomplish. More importantly, you may wonder if it is even something you should care about. So, let’s go behind the headlines and take a little deeper look at the U.S. Leading Economic Indicator.
First, the financial world loves acronyms since many of the economic indicators are a mouthful to articulate. In this case, the common reference to the U.S. Leading Economic Indicator is simply the LEI.
What is the LEI?
The LEI is produced by the Conference Board and composed of 10 economic data points:
Weighting in the LEI
|Average weekly hours in manufacturing||
|ISM new orders index||
|Average consumer expectations for business conditions||
|Interest rate spread (10-year Treasury bonds minus Fed Funds)||
|Leading Credit Index||
|Manufacturers’ new order for consumer goods and materials||
|Manufacturers’ new orders for nondefense capital goods, excluding aircraft||
|Stock prices, S&P 500||
|Average weekly initial claims for unemployment insurance||
|Building permits for new private housing units||
What is the purpose or intent of the LEI?
The purpose or intent of the LEI is to identify changes in the economy before a big change (i.e. recession or recovery) occurs. Think of it as the economy’s “early warning system”. Many of you probably have a weather app on your cell phone that gives you alerts when the weather is about to change (I just got a severe thunderstorm alert on mine). The LEI is intended to alert us to changes in economic conditions that precede a recession or a recovery. The difference is they don’t have an app for the LEI and you only get the updates monthly rather than instantly!
Why should you care?
Let’s use the weather analogy and relate it to the economy. If you know in advance that the weather is going to change for the worse (i.e. recession) or the better (i.e. recovery) then you have an ability to prepare in advance. If the LEI provides an effective early warning system regarding the health of the economy, then individuals and businesses can prepare for what may be coming.
How accurate has the LEI been as an “early warning system”?
Here is how the LEI has performed since the 1980’s:
|June 1979||LEI peaked||January 1980||Recession started|
|May 1980||LEI bottomed||July 1980||Recovery started|
|November 1980||LEI peaked||July 1981||Recession started|
|August 1982||LEI bottomed||November 1982||Recovery started|
|February 1989||LEI peaked||July 1990||Recession started|
|March 1991||LEI bottomed||March 1991||Recovery started|
|April 2000||LEI peaked||March 2001||Recession started|
|October 2001||LEI bottomed||November 2002||Recovery started|
|March 2006||LEI peaked||December 2007||Recession started|
|March 2009||LEI bottomed||June 2009||Recovery started|
As you can see, from a macro perspective, the LEI has provided early warning regarding changes in the economy. As you can also see, there is not a clear pattern of reliability since the early warning time frame has ranged from zero months warning (i.e. the start of the recovery in March 1991) to as long as 21 months advanced warning (i.e. peak in March 2006 until the start of the recession in December 2007).
What is the LEI telling us right now?
Plain and simply, the LEI is telling us that a peak has not yet occurred and thus a recession is not impending.
Remember, the LEI is intended to alert us to changes in the economy; it was not intended to forecast the growth of the economy. Yet, many news stories treat it as an economic forecast and will probably conclude that since the LEI rose faster in August than in July that the forecast is for faster economic growth. The reality is that the LEI rose each consecutive month from March 2013 through December 2013. If the LEI was designed to be a growth forecaster, then that would have led to the conclusion that first quarter economic growth in 2014 would be solid; and yet the U.S. economic growth in the first quarter was negative!
What should be your take-away regarding the LEI?
I believe that the LEI can be a useful “tool” in your “toolbox” for those of you who are trying to gain a better understanding of what is happening with the economy. The key point though is that it is only a tool and not a crystal ball or perfect solution. Two problems exist with the LEI in its current state.
There are many economic indicators that are released on a monthly basis. Before relying on any of them, you need to understand what the indicator is and what it means. The first step in deciding if an economic indicator is useful for you or your business is gaining an understanding of the index. Now that you know what the LEI is and what it was designed to accomplish, you can decide if it is a useful tool for you or your business.
Steve Scranton is the Chief Investment Officer and Economist for Washington Trust Bank and is a CFA charter holder with over 30 years of investment experience with equities, tax-exempt and taxable fixed income securities. Steve actively participates on committees within the bank to help design strategies and policies related to client and bank owned investments. Steve also serves as the economist for the Bank and has been a featured speaker for both client and professional organization events throughout the Northwest.