Two Leading Economic Indicators Point to Another Recession

By: Claus_Vogt

There are two well-known and important leading economic indexes for the U.S. economy:

• The Conference Board’s Leading Economic Index (LEI), and

• The Weekly U.S. Leading Economic Index published by the Economic Cycle Research Institute.

I use them both in my analytical work to better understand the economy’s actual position in the business cycle. And in 2007, they gave me clear, recession warning signs.

So what are they saying now?

Leading Economic Index (LEI) Peaked in March

The LEI is published monthly. Historically its year-over-year percentage change has been one of the best recession forecasting tools available. Whenever it fell below the zero line for three months in a row, a recession followed. And it has never missed calling a recession since the 1960s.

The chart below shows you the history of this indicator. It looks like the LEI saw the high for the current business cycle in March 2010 when the year-over-year change shot up to 11.6 percent. In April it declined to 10.4 percent. And then last Thursday the May figure was released — a drop to 9.2 percent.

Source: Bloomberg

These are still high readings and far from the recession warning level. But what’s important is that the trend of this index has changed direction and is now heading down.

Also noteworthy is that the major positive contributors were the financial components. If you strip them out, the indicator’s recent readings were much worse …

Instead of plus 0.4 percent month-over-month in May, the reading comes in at minus 0.4 percent.

I think it makes a lot of sense to strip the financial components out since history shows that monetary policy looses much of its effects in a post-bubble economy. Hence it’s probable that the LEI is actually overestimating the outlook for the economy!

This apprehension is underlined by the behavior of the second leading economic index for the U.S. economy …

The ECRI Weekly U.S. Leading Economic Index Is Nearing Recession Levels

Last week the Economic Cycle Research Institute’s Leading Economic Index had its second negative reading when it fell to minus 5.7 percent from minus 3.5 percent. As you can see on the following chart, this indicator has been in a steep downtrend for many months and is now at its lowest reading in a year.

Source: Bloomberg

Historically, readings as low the current one have ushered in a recession 80 percent of the time. And readings below minus 8 percent have had a hit rate of 100 percent. So even though it’s not there yet, it’s getting dangerously close.

Lakshman Achuthan from ECRI said that it was premature to call a recession. The negative readings have “not persisted long enough.” I agree. And we’ll have to wait a little longer to know for sure.

Yet one thing is undeniably clear: The risk of a double-dip recession has grown considerably.

Best wishes,

Claus

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