Leading Economic Indicator Points to Spring 2011 Economic Improvement

The Leading Economic Index for October 2010 is suggesting the economy will have a modest economic pickup in the spring.  The headlines:

The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.5 percent in October to 111.3 (2004=100), following a 0.5 percent increase in September, and a 0.1 percent increase in August.

Says Ataman Ozyildirim, economist at The Conference Board: “The LEI remains on an upward trend, suggesting the modest economic expansion will continue in the near term. The LEI’s growth has been slowing this year, but gains in the financial components helped its pickup in October.”

Says Ken Goldstein, economist at The Conference Board: “The economy is slow, but latest data on the U.S. LEI suggest that change may be around the corner. Expect modest holiday sales, driven by steep discounting. But following a post-holiday lull, the indicators are suggesting a mild pickup this spring.”

The Conference Board Coincident Economic Index® (CEI) for the U.S. increased 0.1 percent in October to 101.5 (2004=100), following no change in September, and no change in August.

The obvious is that the cutoff for October data is the end of October.  Since the beginning of November, some poor economic data is creeping in.  The problem with the LEI is that it is moved heavily by money dynamics and flows.

Because of new factors such as QE and unprecedented deficit spending, the LEI looks like it is a rocket ship headed for lunar orbit.  It is showing economic strength or potential higher than before the Great Recession.  Simple observation of many economic factors warns you this is not true.  Using a heavy weighting of financials in these unusual times likely will yield the wrong answer.

The Weekly Leading Index for ECRI – the other major leading economic indicator – is in negative territory (but slowly becoming less bad over the last month or so).  It ventures to look ahead six months also, and is not suggesting the economy is in for a Spring surprise.  The Consumer Metrics Institute is also indicating a more modest economy as the Daily Growth Index for consumer spending appears to have just reached a deep bottom and has started to rise.

[update by author: 20 November 2010]

The Bank of Tokyo – Mitsubishi UFG (BTMU) published an analysis of the LEI in their U.S. Business Conditions Weekly.  Although there are some small (tiny) elements of this analysis which I do not agree with, I do accept their basis of analysis and the major thrust of their argument.  They state in part:

In October, the largest contributors to the LEI’s growth were once again the yield curve and the real money supply. Unfortunately, both are indicative of the incredible amount of support from the Federal Reserve to prop up the economy, rather than improvement in fundamental growth. Recent literature from the San Francisco Federal Reserve Bank suggested that any leading indicator using the yield curve may be providing false readings that are stronger than actual economic activity would suggest. That’s because the curve cannot invert when the Fed is stuck at a near zero-bound interest rate policy. An inversion of the yield curve is typically a strong signal of recession, so it is an important indicator to include in the LEI, but as can be seen in the graph above, it has been responsible for most of the strength in the LEI since the Fed began its first QE program in the spring of 2009. Incidentally, we showed this graph during a Bloomberg segment on Thursday, November 18th, and have received a slew of inquiries and comments since. In the graph above [below in this article], we’ve taken the LEI and created two sister data series, one that takes out the yield curve component and another that takes out the yield curve and real money supply. Indexing those data series to December 2007, the start of the recession, shows an amazing difference between the fundamental performance of the economy with and without the Fed’s help.

The LEI with the Yield Curve and M2 removed begins to look very similar to ECRI’s WLI. BTMU also broke down the monthly contributions to the LEI.

As a number cruncher, the above graph took significant data gathering and analysis to produce – it would have taken me a man-day of effort.  I tip my hat to BTMU.

Looking ahead however, BTMU sees an improving economy.

There’s better news ahead, however. September and October represent the first two months that the LEI — without the help of the yield curve and real money supply — has increased since early 2010, suggesting that the U.S. economy is fundamentally gaining ground, and goes far to explain why grumblings (for the most part) of a double-dip recession have subsided. October in particular saw a better report on payrolls in which the workweek expanded and the diffusion of growth across industries was healthier. We also received a better-than-expected October retail sales report, which points to good consumer momentum going into the holiday shopping season.

Econintersect is not convinced that the good retail sales numbers (Econintersect’s analysis here) are due to the consumer coming back to the table – but more likely October’s retail sales growth are due to retailers pulling Christmas sales into October.

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