- Leading indicators weakened in August, but are not yet flashing a recession warning.
- Recession models show rising, but still low risk of a coming contraction in economic activity.
- Economic recoveries don’t tend to die of old age; they die of excess…of which there’s little in this recovery.
I keep a close eye on every variety of leading economic indicators—of which the stock market is one. Last week’s release of the most-widely followed set of leading indicators—the Conference Board’s Index of Leading Economic Indicators (CB’s LEI)—showed an unexpected decline of 0.2%. Each month I put together a “dashboard” of these leading indicators in order to see any flashpoints. The LEI has ten sub-indexes and it’s important to judge each not just on their level, but their trend and rate of change. This is because when it comes to the relationship between the economy and the stock market, it’s typically the case that better or worse matters more than good or bad. In other words, inflection points in the data are often more telling than the level of the data point.
Below is a long-term chart of the LEI. As you can see, the peaks occurred well in advance of the onsets of recessions—on average by more than 12 months. And in the case of the three most recent recessions, the LEI had “round-tripped” (taken out its prior high) at least four years prior to the subsequent recessions. So, if a recession is imminent today, it would be unprecedented for the LEI not to give sufficient warning.
Source: FactSet, The Conference Board, as of August 31, 2016.
As you can see above, the LEI presently remains below its prior (2006) high and has yet to signal a definitive turn for the worse. Yes, August’s reading was negative and worse than expected, but as noted, there are usually months and months of deterioration before recessions ensue. August is also a month notoriously prone to economic data revisions—especially jobs-related data. So, the net is it’s too soon to declare victory for the economic bears.
Before I get to the level and trend analysis of the LEI’s components, I also want to highlight two additional leading indexes. The first chart below shows the Economic Cycle Research Institute’s Weekly Leading Index (ECRI’s WLI), which is also not flashing a warning about a coming recession. The second chart shows the OECD U.S. Composite Leading Indicator, which does show an alarming decline recently. However, do note there are three precedents—in the mid-1960s, mid-1980s and mid-1990s—when the index dropped significantly, but they turned out to be mid-cycle slowdowns, not recessions.
Source: ECRI (Economic Cycle Research Institute), as of September 16, 2016.
Source: FactSet, OECD (Organization for Economic Coordination and Development), as of July 31, 2016.
One of the reasons for the popularity of the CB’s LEI is that the CB is transparent with its underlying data, and the sub-indexes are easy to track. There are ten sub-indexes within the LEI and below is the aforementioned dashboard showing a color-coded review of the individual indicators.
Source: Charles Schwab, The Conference Board, as of August 31, 2016.
There is unquestionably a bit more red on the page than there was last month, with ISM new orders and consumer confidence particularly bearing watching. But I don’t yet view this as particularly alarming.