The Leading Economic Index (LEI) is a predictive tool designed to signal the ebbs and flows of the economy, providing early indicators of a potential recession. Managed by The Conference Board, the LEI aggregates a wide spectrum of economic data to present a comprehensive yet digestible picture of the economic landscape.
Bias toward Recession ✅
The Background
The Conference Board is a member-driven think tank established in 1916, dedicated to providing economic insights.
The creation of the Leading Economic Index (LEI) is a part of a broader mission to help policymakers make informed decisions. The LEI is designed to signal early warnings of economic shifts. By aggregating ten different economic indicators into a composite index, the LEI provides a broad-based look at the health of the economy, encapsulating various sectors and types of economic activity.
The LEI, in particular, has become a crucial tool for those looking to gauge the economy’s forward momentum and prepare for possible turns in the business cycle.
The 3Ds: Duration, Depth, and Diffusion, are crucial metrics employed in interpreting the LEI to provide insights into the economic climate, particularly the onset of a recession. Here’s a more detailed breakdown of each:
- Duration: This refers to the longevity of a decline in the index, essentially measuring how sustained a downward trend is. Persistent declines over extended periods may indicate more systemic economic issues, flagging potential recessionary conditions.
- Depth: Depth quantifies the magnitude of the decline in the index, providing a sense of the severity of economic contraction. A deeper plunge in the index could signify a more pronounced economic downturn, making it a vital metric for gauging recession severity.
- Diffusion: This metric assesses how widespread the decline is across different sectors and types of economic activity, encapsulated within the LEI. It provides a measure of the breadth of economic contraction, showing whether economic woes are isolated or broad-based.
A persistent downward trend in the LEI serves as a cautionary signal. Historically, the LEI tends to reach its peak approximately 11-12 months before a recession, embarking on a downward trajectory thereafter. A notable metric within the LEI is the examination of the six-month change in the index. When the US LEI experiences a decline of more than 4% over a six-month span, it ventures into recessionary territory, which is indicative of the economy losing momentum, a critical aspect in foreseeing economic directional changes.
To refine the signal further, the Diffusion Index comes into play, measuring the breadth of changes across the LEI components over a six-month period. A reading above 50% denotes that a majority of the LEI components have risen over the preceding six months, while a reading below 50% indicates a majority have fallen, with the latter being a stronger signal of a potential economic downturn.
The concept of the 3Ds – Duration, Depth, and Diffusion, collectively provide a holistic view of the economic shifts. An impending recession is signalled when the decline in the index over the most recent six months falls below the threshold of -4.0%, and simultaneously, the diffusion index dips below the threshold of 50.
The Metrics
Overal index:
| Indicator | Current Status | Recession? |
| Index at -4% | Below -4% recession warning | ✅ |
The individual indicators:
| Indicator | Current Status | R? |
|---|---|---|
| Average weekly hours, manufacturing | down from Mar ’22 high | ✅ |
| Average weekly initial claims for unemployment insurance | down 20% from March ’23 local top | ➖ |
| Manufacturers’ new orders, consumer goods and materials | down from June ’22 high, but turned up again | ➖ |
| ISM Index of New Orders | Down from high of Jun ’22 but turned upwards again | ➖ |
| Manufacturers’ new orders, non-defence capital goods excluding aircraft orders | All Time High | ❌ |
| Building permits, new private housing units | Down from Dec ’21 high, but might have found local bottom | ✅ |
| Stock prices, 500 common stocks | Has been on a run, but has rolled over and is in decline | ➖ |
| Leading Credit Index™ | Proprietary index, we can’t check data | ➖ |
| Interest rate spread, 10-year Treasury bonds less federal funds | Coming off it’s lows, towards zero | ✅ |
| Average consumer expectations for business conditions | up from historic low Jun ’22 but way under 100 (bearish) | ✅ |
The narrative
In a scenario where economic tides are turning for the worse, several of the LEI indicators would start signalling caution. For instance, manufacturing may begin to slow down due to declining orders, reflected in a reduction in average weekly hours in manufacturing.
Concurrently, businesses might become hesitant to invest in new projects, leading to a dip in new orders for non-defence capital goods excluding aircraft.
As consumer confidence wanes, there might be less spending on goods, impacting retail sales adversely. This decline in consumer spending often goes hand in hand with a tightening job market as businesses look to cut costs, leading to an uptick in average weekly initial claims for unemployment insurance.
On the housing front, a less optimistic outlook on the economy can lead to fewer building permits being issued as both builders and potential homeowners hesitate to make significant financial commitments.
In the financial markets, stock prices might start to falter as investors grow wary, while the Leading Credit Index™ might suggest tightening credit conditions, making it harder for businesses and consumers to access credit.
Moreover, the interest rate spread might narrow, reflecting a less optimistic outlook for the economy. In a situation where commodities prices fall, it might signal declining demand which can be a precursor to an economic slowdown.
All these indicators are interconnected. For instance, reduced consumer spending affects business revenues, leading to cutbacks in production and possibly further job losses.
These, in turn, can create a cycle of declining economic activity.
Where are we?
Based on the index, we are still deep into a recession signal (below -4% on their index) and as such we can expect a recession.
However, until a few months ago, almost all the individual indicators were green ticks, now a few are starting to show signs of strength.
New orders, in particular, is a leading indicator and this could be a sign of an entering economic strength.
We don’t know, however, exactly how this feeds into the overall index, and won’t draw any conclusions from this most recent snapshot.
Bias towards recession ✅
Credit
All credit goes to the Conference Board for creating and updating the Leading Economic Indicator. Please keep up to date with them on their website or the social platforms below:
https://www.conference-board.org/topics/us-leading-indicators