Is Unemployment Now A Leading Indicator? No!

Tuesday, November 3, 2009

employees onlyPoliticians and the media can be forgiven for focusing on high unemployment, with forecasts of higher levels. Their fear is that Main Street will not share Wall Street’s gains.

But a group that should know better, investment professionals and economists, have some members saying times have changed and unemployment should be viewed as a leading indicator. They believe the rate is too high and is destined to remain there too long for the economy to fix itself until more jobs are created. Here is what is wrong with that argument…

Leading indicators are not measures of economic growth per se. Rather, they are the precursors of economic growth. To argue that the general unemployment rate must improve before the economy does is simply wrong. Businesses will first stop laying off workers and start using their employees more fully before they will create new jobs. That is why initial unemployment claims and average hours worked in manufacturing are true leading indicators. Importantly, these have both shown improvement:

Unempl leading ind

Economic cycles have been studied in depth for decades – back to the 1800s for the US. The Conference Board’s Economic Indexes are built on that work. Here is the composition of the three indexes:

Leading Economic Index (10 measures):

Employer/production

  • Manufacturers’ new orders, consumer goods and materials
  • Manufacturers’ new orders, non-defense capital goods
  • Index of supplier deliveries – vendor performance
  • Building permits, new private housing units

Employee/consumer

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Index of consumer expectations

Financial

  • Stock prices, 500 common stocks
  • Money supply, M2
  • Interest rate spread, 10-yr Treasury bonds less federal funds

Coincident Economic Index (4 measures):

Employer/production

  • Industrial production
  • Manufacturing and trade sales

Employee/consumer

  • Employees on nonagricultural payrolls
  • Personal income less transfer payments

Financial

  • – none –

Lagging Economic Index (7 measures)

Employer/production

  • Inventories to sales ratio, manufacturing and trade
  • Labor cost per unit of output, manufacturing

Employee/consumer

  • Average duration of unemployment
  • Consumer installment credit to personal income ratio

Financial

  • Average prime rate
  • Commercial and industrial loans
  • Consumer price index for services

These well-chosen measures still seem appropriate, even given the broad-based turmoil we have been through. Improvement has been showing up in the leading indicators, and the coincident indicators are stabilizing. There is no need to fret because the lagging indicators have not turned yet.

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