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Leading Economic Hope
Floyd Norris at the NYT is excited about the Index of Leading Economic Indicators. Let's peek under the hood to see what's going on.
Yes, historically the LEI has had an impressive relationship with national output growth. The chart below plots the 3-month moving average of the monthly LEI change figure (annualized) versus the quarterly growth rate in US GDP. The relationship is both strong and leading.
But this time around something seems a little off - even the optimists at Barclays Capital forecast positive US GDP of only +2.5 in Q3 and +3.5 in Q4. The LEI's suggestion of 12% seems a bit rosy...
As it turns out, self-reinforcing market-based indicators and sentiment are driving the bounce-back in the LEI index, rendering it suspect as a measure of economic health this time around (in fairness, Floyd alludes to this in the NYT article, but I think his emphasis is wrong).
The LEI index is a composite of several underlying components. Looking at the table you'll notice that the biggest contributors to the past 3 months' +3% QoQ change (non-annualized) were positive contributions from 1) yield curve steepness, 2) Stocks, 3) Deliveries, and 4) Consumer Confidence.
So three out of the four contributors to the strong LEI prints, driving over 70% of the recovery in this index, are based on self-referencing markets, presumed bank profitability and expectations. Indicators representing final demand (employment, consumer purchases, wages) are doing horribly.
Eventually, unless final demand shows signs of recovering, the gap between the the LEI index and the real economy will get too large, and the index will capitulate. That means a reversal in stocks, bank performance and sentiment.
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Thank you for the breakdown nickbarbon ! Very good and informative post.
good column.
government data subject to future revision. i'm sure glad i'm not smart enough to use fundamentals.
"The LEI is a Strange Loop"
Speaking of strange loops ...does Floyd Norris really think the US has a more promising economic future than a five year- old sportin' a mullet?
Hell...while on the subject of strange loops (as well as one outstanding leading indicator)....I just have to say: Isn't it discomfiting to witness a kid that's too young to know better going with the Billy Ray Coiffure? I still haven't figured it out: Was it actually a conscious decision on the part of the parent(s) to let their progeny go business up front/party in the back...OR...Is the unfortunate hairstyle simply the result of a genetic predisposition? [Possibly the result of some abnormal follicle overload on the back side?]
Over a year ago, people were wondering if a negative financial shock could bring down the real economy. It did. In similar fashion, we could see these sentiment indicators pull up the real demand numbers.
Either way the real numbers go, this data worth following.
Look at the Weekly Railfax - Rail Carloading Report. The trend does not look like like any significant uptick in expectations, IMHO.
http://railfax.transmatch.com/
The index of leading indicators includes as well:
The interest rate spread between 10-year Treasury notes and the federal funds rate (Fed economists prefered benchmark as a gauge to recession Fed fund, 3 months. 10 years yields spread.
In addition to the circular self made men or computers driving Pigou s effects, the yield curve spread has been so much tortured that it could not be foretelling a recession and was still saying no recession few months after officially aknowledged.
All answers to the math quiz in base 10?
Does anyone know if LEI is used to price expectations in Bonds market? That would be funny, spreads tightened, so LEI gets better and follows more circular reasoning.
The table talks about deliveries- deliveries of what? How convenient is the Index to weigh down the actual economic components ? Right, it is called L expectations I!
I really appreciate the careful breakdown of the LEI... thanks!
Awesome. Of course, this very simple yet prescient and accurate analysis will gain exactly 0 traction in the MSM, and most of the blogosphere, sigh...