These Three Economic Gauges Read “OK”

Monday, March 22, 2010

Investors, analysts and pundits can look at the same economic measures and come away with opposing views as to the economy’s health and future. The economy’s “trees” can range from vibrant to blighted, allowing differing economic “forest” diagnoses.

As a result, we see predictions of economic normalcy and growth side-by-side with reversal and collapse. Likewise, the US stock market is viewed either as attractively valued with growth potential or overbought and destined to plummet.

However, there is a sound and accepted way to view these economic indicators that creates a reliably cohesive picture…

For decades (even centuries) economic data in all major developed countries has been gathered, studied and analyzed. This large body of work, carried on by both academics and practitioners, has produced an extensive understanding of how an economy works and behaves: its components, drivers, interrelationships, trends and cycles (short-, intermediate- and long-term).

What seems especially important today is to understand two things:

First, the established principles still hold. It is tempting to think that we live in a different era with a different set of rules – saying “this time is different.” However, such a statement in the face of widespread economic knowledge requires more than just saying so and pointing to the odd-looking indicator as proof. Economies, like investment markets, are not governed by a rigid set of rules. For any number of reasons, an economic indicator can appear uncharacteristic and even be inaccurate (see “Take Indicator News with a Grain of Salt”).

By the way – if someone says, “This time is different,” a proper response is “Prove it.” To prove that this time is truly different requires a complete economic treatise, with a thorough study: a new and sound theory, an explanation of how to test this theory, a data collection methodology, a statistical analytical process and then an evaluation of the final results, objectively tested and found to be statistically significant.

Second, economic indicator trends generally reflect a logical order of progression. For example, investors are forever looking ahead to what comes next. Therefore, the stock market tends to rise or fall ahead of other indicators and is considered a “leading” indicator. A measure that moves in line with the general economy (e.g., industrial production) is considered a “coincident” indicator. Then, there are those that change direction after the economy does. These are “lagging” indicators (e.g., banks’ commercial and industrial loans).

Note that congress has been fretting over this laggard not happening fast enough. Well, there is good reason why banks delay increasing loans. They need to gain confidence in the economic trend as well as see a significant reduction in late payments and defaults.

To track these groups of indicators, the Conference Board’s U.S. Business Cycle IndicatorsSM is best. There are three widely-followed indexes:

  1. The Conference Board Leading Economic Index®
  2. The Conference Board Coincident Economic Index®
  3. The Conference Board Lagging Economic Index®

The February report was issued last Thursday (March 18) and can be found at The Conference Board website. There are two PDF files listed. Click on the first for both the results and information about the construction of the indices, including long-term graphs on the last page. Click on the second to see the press release with graphs of the first two indexes, superimposed.

The noteworthy items are the following.

  1. The leading index has been climbing since March 2009 and is now well above its historic highs.
  2. The coincident index turned up in July 2009. Its steady but slow rise is typical at this stage.
  3. The lagging index just produced its first positive reading last month (February 2010).

So, if you can stay away from thinking “this time is different” and simply view this economy using these three established measures (gauges), everything looks OK.

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Important note: housing. Housing deserves special mention because it combines both economic conditions (e.g., consumer income and interest rates) with investment measures (e.g., equity growth and optimism). Because we had a sizable bout of house investing fever, we are going through a shakeout, exacerbated by the economy’s weakness. This is similar to the shakeout in the US stock market following the internet stock investment craze ten years ago. Expect housing in overbuilt areas to recover slowly because excess inventory needs to be reduced. Likewise, in 2001-2003, the “overbuilt” internet industry had to be cleared out before that part of the US stock market could begin to recover in earnest. IMPORTANT: Do not apply these thoughts to everything labeled “housing.” Just like the US stock market, where areas that were excluded from the internet bubble performed well, the non-overbuilt housing areas (and this is almost everywhere) should improve nicely as the economic conditions continue to recover. (See: “A Robust Housing Market – 2010’s Biggest Surprise?”)

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Previous articles about economic indicators:

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