April 2014 Chemical Activity Barometer: Suggests Economy May Gain Momentum

from the American Chemistry Council

The Chemical Activity Barometer (CAB) has reached its highest peak since March 2008. Even accounting for seasonal adjustments, the unusually harsh winter skewed earlier data, and this month’s barometer reflects upward revisions for January, February, and March of 0.1, 0.2, and 0.1 points, respectively. On a three-month moving average (3MMA) basis, the April CAB reading showed a healthy 0.5 percent gain over March. Together with the upward revisions, this suggests further growth momentum in the broader economy in the months ahead.

Recent Federal Reserve data showed U.S. manufacturing output rose for the second consecutive month, and that industrial production was up 0.7 percent, besting many analysts’ expectations. Tracking closely with the CAB, the Federal Reserve data also revealed capacity utilization to be at its highest point since June 2008. The CAB, shown to lead U.S. business cycles by an average of eight months at cycle peaks stands at 95.2, up 3.2 percent over one year ago, and is showing an increased pace of growth over the fourth quarter of 2013. Overall results in four primary components of the CAB were mixed-to-positive, with product/selling prices, production, and inventories up, while equity prices were flat, but still outpacing the broader market.

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Said Kevin Swift, chief economist at the American Chemistry Council:

After an economic deep freeze over the past several months, it looks like the U.S. economy is finally starting to bloom. Economists around the country are coalescing around the idea that the fundamentals of our economy may be healthier than previously believed. This is something that the Chemical Activity Barometer has been suggesting for quite some time,

Caveats on the Chemical Activity Barometer (CAB):

The definition of the CAB:

Chemical Activity Barometer (CAB) is a leading economic indicator derived from a composite index of chemical industry activity. The chemical industry has been found to consistently lead the U.S. economy’s business cycle given its early position in the supply chain, and this barometer can be used to determine turning points and likely trends in the wider economy. Month-to-month movements can be volatile so a three-month moving average of the barometer is provided. This provides a more consistent and illustrative picture of national economic trends.

Applying the CAB back to 1919, it has been shown to provide a longer lead (or perform better) than the National Bureau of Economic Research, by two to 14 months, with an average lead of eight months at cycle peaks. The median lead was also eight months. At business cycle troughs, the CAB leads by one to seven months, with an average lead of four months. The median lead was three months. The CAB is rebased to the average lead (in months) of an average 100 in the base year (the year 2007 was used) of a reference time series. The latter is the Federal Reserve’s Industrial Production Index.

This index is a mixture of monetary / non-monetary elements with an analysis methodology which is not transparent – and does include some non-chemical industry elements such as the ISM manufacturing index and residential building permits. The composition and concept of the CAB according to the authors:

The CAB comprises indicators relating to the production of chlorine and other alkalies, pigments, plastic resins and other selected basic industrial chemicals; chemical company stock data; hours worked in chemicals; publicly sourced, chemical price information; end-use (or customer) industry sales-to-inventories; and several broader leading economic measures (building permits and new orders). Each month, ACC provides a barometer number, which reflects activity data for the current month, as well as a three-month moving average. The CAB was developed by the economics department at the American Chemistry Council.

The Chemical Activity Barometer is a leading economic indicator derived from a composite index of chemical industry activity. The chemical industry has been found to consistently lead the U.S. economy’s business cycle given its early position in the supply chain, and this barometer can be used to determine turning points and likely trends in the wider economy. Month-to-month movements can be volatile so a three-month moving average of the barometer is provided. This provides a more consistent and illustrative picture of national economic trends.

Applying the CAB back to 1919, it has been shown to provide a longer lead (or perform better) than the National Bureau of Economic Research, by two to 14 months, with an average lead of eight months at cycle peaks. The median lead was also eight months. At business cycle troughs, the CAB leads by one to seven months, with an average lead of four months. The median lead was three months. The CAB is rebased to the average lead (in months) of an average 100 in the base year (the year 2007 was used) of a reference time series. The latter is the Federal Reserve’s Industrial Production Index.

As this is a relatively new leading index, our biggest concern is backward revision (which degrades real time accuracy). Thankfully (providently?) backward revisions have been relatively small to date.

No single economic forecasting index has proven to have all the answers, as the reason the economy recesses is a combination of changing dynamics. Econintersect will continue to review this leading index and others as part of our monthly economic forecast.