June 2012 Leading Economic Indicator Forecasting Softening Economy

Written by Steven Hansen

Warning: This post contains more soft economic forecast news.

The Conference Board Leading Economic Index (LEI) for the U.S. declined 0.3% in June to 95.6 (2004 = 100), following a 0.1% increase in May.

This index is designed to forecast the economy six months in advance. The market expected a decline of -0.2% in the LEI (versus the -0.3% reported).

Additional comments from the economists at The Conference Board add context to the index’s behavior.

Says Ataman Ozyildirim, economist at The Conference Board: “The U.S. LEI declined in two of the last six months, and its six-month growth rate has eased in the last three months. The strengths among the leading indicators have become less widespread as consumer expectations and manufacturing new orders offset gains in the financial, labor, and construction-related components. Meanwhile, the coincident economic index, a measure of current economic conditions, has risen slowly but steadily in the last three months.”

Says Ken Goldstein, economist at The Conference Board: “The U.S. economy is growing very slowly. The CEI basically reflects this steady but soft pace of overall economic activity. The LEI is pointing to no strengthening over the next few months, as the economy continues to sail through strong headwinds domestically and internationally.”

And here is the June 2012 new and improved LEI which shows the index at levels below the pre-2007 recession – as well as showing some turbulence in the indicator’s post recession climb – note that Econintersect believes there should also be a dip in 2010 based on historical data:

LEI as an Economic Monitoring Tool:

The usefulness of the LEI is not in the headline graphics but by examining its trend behavior. Econintersect contributor Doug Short (Advisor Perspectives / dshort.com) produces two trend graphics. The first one shows the year-over-year growth, as well as the three month rolling average of the rate of change – shown against the NBER recessions.

For a better view of the current conditions, the above chart is zoomed below to better show the current timeframe.

As an analyst, I keep my eyes on 3 month rate-of-change (red bars). There is a short term (3 month) trend of degrading rate of growth – but the growth is positive. The recession warning follows months of negative growth of this index. This is why the authors of this index are saying no recession is coming this year.

This is the seventh month of the “new and improving” Leading Economic Index from The Conference Board, and might prove to be a viable real time long range forecasting tool.

Only in hindsight years from now will we know. As a comparison to the LEI, ECRI’s WLI (which Econintersect reports on weekly) is now again trending negative indicating a contracting economy six months from today. Further ECRI is now saying we are in a recession – and is in direct conflict with The Conference Board’s LEI.

Current ECRI WLI Index

Econintersect believes the USA economy is currently weakly expanding, but our forecast only looks ahead one month (analysis here).

Caveats on the Use of the Leading Economic Index (LEI)

This index is produced by The Conference Board (a private money making company) – who charges for the details of the indices they publish – although the summary of this index is available to the public. Its designed to predict economic growth over the next six months.

This is not a “black box” economic forecasting index as The Conference Board publishes the components. It was completely revised with the release of the December 2011 (analysis comparing the old and new index components – click here). The new components of the index and multipliers:

The index does not adjust for inflation or population growth, is not final for several months after being published, and is subject to annual revision. The methodology in producing this index:

1) normalized levels of the indicator rather than its monthly changes will be used to calculate the component contributions of components based on diffusion indexes such as the ISM New Orders Index; 2) when component data are missing, autoregressions in log differences instead of levels will be used to calculate the statistical imputation of the missing months; 3) trend adjustment will be done in two periods: 1959-1983 and 1984-2010 (same as the volatility adjustment); and 4) LCI contributions to the LEI are calculated from its levels (not monthly changes) and it is inverted As a result of these changes, the history of the revised indexes and their month-over-month changes will no longer be directly comparable to those issued prior to the comprehensive benchmark revision. Based on its performance since 1990, and especially before and during the 2008-2009 recession, the new LEI should provide more accurate predictions of business cycle peaks and troughs.

Econintersect has published correlations of the new LEI to past recessions. At first glance this index provides recession warning.

The fly-in-the-ointment is that this analysis is that the above graph is not a real time analysis. Consider that the LEI is not final when first issued – it is subject to revision for months. From The Conference Board:

To address the problem of lags in available data, those leading, coincident and lagging indicators that are not available at the time of publication are estimated using statistical imputation. An autoregressive model is used to estimate each unavailable component. The resulting indexes are therefore constructed using real and estimated data, and will be revised as the unavailable data during the time of publication become available. Such revisions are part of the monthly data revisions, now a regular part of the U.S. Business Cycle Indicators program.

The data does not exist to establish what The Conference Board’s LEI values would have been in real time – at this point only the final numbers are known. Unfortunately, knowing the current values is no assurance that a recession is or is not imminent as there is no track record of real time performance.

Related Articles

Conference Board: LEI to be Revised by Lance Roberts (GEI News, 19 Jan 2012)

Can ECRI’s Weekly Leading Index be Trusted? by Georg Vrba, P.E.

All Posts on Leading Economic Indicator All Posts on Economic Forecasts

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