Misleading Economic Indicators?

The following excerpt is from our August 23, 2023 Morning Briefing.

While we await Fed Chair Jerome Powell’s Jackson Hole speech on Friday, which is bound to impact the financial markets, let’s review the latest composite economic indexes.

The Conference Board compiles the Index of Leading Economic Indicators (LEI), the Index of Coincident Economic Indicators (CEI), and the Index of Lagging Economic Indicators (LAGEI). July’s indexes were released last week on Thursday. Collectively, they are a mixed bag. The LEI continues to ring the alarm bell about a recession, while the CEI continues to confirm that the economy is growing. The LAGEI is showing signs of peaking, which is what it does near the end of recessions.

So which one is right? Is the economy about to fall into a recession? Is it not about to? Or has it been in a rolling recession, which is almost over? We pick Door #3.

Here’s what we make of this trio’s July readings:

(1) LEI. The LEI peaked at a record high during December 2021 (Fig. 1). It is down 10.2% since then through July. It has declined for the past 16 consecutive months. It has correctly signaled the last eight recessions with an average lead time of 12 months. So a recession is overdue.

Debbie and I have previously shown that the yearly percent change in the LEI is highly correlated with the national M-PMI (Fig. 2). The same can be said for the former and the yearly percent change in real GDP for goods (Fig. 3). There’s almost no correlation between the yearly percent changes in the LEI and real GDP for services (Fig. 4).

We previously have shown that five of the 10 components of the LEI are related to the goods economy, which tends to be more cyclical than the services economy (Fig. 5). Three of the 10 relate to the financial markets. Two of the three track the labor market and consumer expectations. So the LEI over-weights the goods economy, which has been in a recession while the services economy has been booming.

In current dollars, services now account for 60.5% of nominal GDP, up from 39.8% at the start of the data in 1947 (Fig. 6).

(2) CEI. The CEI rose to a record high during July (Fig. 7). Its yearly percent change closely tracks the yearly percent change in real GDP (Fig. 8). Of its four components, two rose to record highs in July (payroll employment and real personal income less transfer payments), while the other two have stalled in recent months at their record highs (real manufacturing & trade sales and industrial production). The yearly percent change in the CEI also tends to be more highly correlated with the growth rate of real GDP goods than real GDP services (Fig. 9 and Fig. 10). Nevertheless, it is still making new highs and not peaking as it always does when a recession is starting.

(3) LAGEI. The LAGEI is the Rodney Dangerfield of the composite cyclical indicators. It gets no respect. It’s rarely mentioned. That’s because it tends to peak at the end of recessions and trough well after they end (Fig. 11). Oddly, it seems to be peaking in recent months, suggesting that the no-show recession is almost over! Perhaps, it is signaling that our rolling recession is over and that a rolling recovery is underway.

It’s also interesting to monitor the seven components of the LAGEI (Fig. 12). Like the Seven Dwarfs, some are sleepy, some are grumpy, while others are happy. We often hear that record consumer installment credit may force consumers to retrench, causing a recession. The ratio of consumer installment credit to personal income is actually a lagging indicator, not a leading or coincident one. So are the six-month percent change in the CPI for services and—perhaps surprisingly to some—inflation-adjusted commercial & industrial loans.

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