Oct 24, 2022

An Arcane Index Flashes a Warning

Weekly Market Commentary

Every month, the Conference Board releases what’s called the Leading Economic Index, or the LEI. The LEI consists of 10 economic components, whose changes tend to precede what happens in the economy.

The LEI has always turned lower before the onset of a recession, and ticks higher near the end of a recession.

The components of the LEI include data on layoffs, production orders, housing, and credit market indicators.

Unlike the unemployment rate or data on inflation, the LEI is far from a household name. The monthly report rarely moves the market.

However, among economists and analysts, it is viewed as a top-tier economic release.

But with inflation, sharply higher interest rates, worries about the economy, and a volatile stock market, today’s environment is far from ordinary.

Why are we focusing on the LEI? The index has fallen in six of the last seven months, according to the Conference Board, including a 0.4% decline in September. The index was unchanged in August.

Why is the LEI an important gauge of economic trends? It is a compilation of 10 leading economic indicators. One report could give a false signal, but a gauge of 10 offers a better consensus.

Going back to 1960, the LEI has a perfect record of calling recessions, but nailing the onset of a recession is not its strong point.

According to Advisor Perspectives, a recession began anywhere from one month (1960) to 20 months (2008) after the LEI peaked.

Excluding 2020, the average start date for the last 5 recessions (back to 1980) has been 14 months after the LEI peaked.

In its September report, the Conference Board warned a recession is increasingly likely, possibly this year. If the historical data play out, a recession might start in the second quarter of 2023 (the LEI peaked in February 2022).

But let’s be careful trying to pinpoint a new recession.

Timing is important, and the LEI doesn’t have a solid record of picking a start date. In addition, it is possible trends could change, and we might avoid a recession next year.

Nonetheless, given today’s environment, the pronounced slide in the LEI bears watching.

Separately, the Wall Street Journal reported on Friday that the Fed is likely gearing up for another outsized rate hike in November. But, according to the unconfirmed report, some Fed officials are signaling greater unease with further outsized rate increases after November.

The story contributed to Friday’s rally.

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