The Conference Board released September data from their composite economic indexes. Their Leading Economic Index (LEI), which compiles 10 leading economic indicators, reported a small decline for the 2nd month in a row. Its smoothed 6-month growth rate has been gradually slowing since the 4th quarter of 2018 to a near flat position through September (+0.4%). Trade disputes are clearly weighing on the industrial and manufacturing components of the index, particularly new orders. The ISM New Orders Index has contracted for the prior 2 months and measures 42% lower than its peak in this post-Financial Crisis economic expansion. We’re keeping an eye on the LEI to either regain its momentum and carry capital markets higher as it did in 2013 and 2016, or to turn negative and warn us of an upcoming economic recession as it did in previous cycles.
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I’ll give everyone a reprieve from trade negotiations and central bank policy discussion this week. It’s easy to get bogged down in the stories and details around U.S. and China trade negotiations, Brexit, and another round of Quantitative Easing (QE Lite). To quote Mr. October, Reggie Jackson, they are the straws that stir the drink. And deservedly so, but I also want to look at the latest actual economic data to analyze.
The Conference Board’s composite economic indexes are a good place to start, particularly their Leading Economic Index (LEI). We’ve discussed the LEI in past Weekly Insights, but it’s a composite of ten data points that have historically been leading indicators of economic activity. The data points include a mix of production components (building permits, ISM new orders index, manufacturing new orders), employment components (manufacturing hours worked, initial unemployment claims), market data (S&P 500 index, bond yield curve, Leading Credit Index), and soft data (consumer expectations).
As you will note above, the smoothed LEI growth rate has been slowing all year. Based on September data, the latest release reports a measly 6-month growth rate of +0.4%. Now, it’s not the first time in this economic growth cycle that the index growth rate has flirted with negative territory. We saw similar regressions that bottomed in 2013 and 2016 before turning around. However, if this is not another close call and the LEI rate of change turns negative, the lead time before an economic recession has ranged anywhere from 2 months to 15 months for the last 7 economic recessions. For more perspective, the average LEI rate of change in the month prior to the recession start is -4.9% (+0.4% currently).
The LEI has been a fairly reliable index of leading economic indicators and has a long track record. Its current level sits near all-time highs, but has hardly made any progress this year, hence the virtually flat 6-month growth rate. For context, the LEI level was at 111.7 in March, and it’s 111.9 today. It has declined slightly for the last 2 months, but not enough to materially impact its overall trend.
Charles Schwab puts together a good monthly recap of both the level and trend of the LEI as well as the Coincident Economic Index (CEI) along with their individual components.
Looking at the table above, you will notice most of the production components have worsening trends, led by the Institute for Supply Management (ISM) New Orders Index. The ISM New Orders Index is based on new industrial orders data compiled from purchasing and supply executives nationwide. It has shown a contraction in new orders for the 2nd consecutive month (consistent with the LEI’s movement). Those last 2 months have been the lowest reading since June 2012, while the previous low point was in April 2009. ISM’s Timothy Fiore, when commenting on the widely tracked composite manufacturing PMI index, specifically noted the weakness in new orders. “Global trade remains the most significant issue, as demonstrated by the contraction in new export orders that began in July 2019. Overall, sentiment this month remains cautious regarding near-term growth.”
The Conference Board’s Ataman Ozyildirim had a similar summation of their latest report. “The LEI reflects uncertainty in the outlook and falling business expectations, brought on by the downturn in the industrial sector and trade disputes. Looking ahead, the LEI is consistent that is still growing, albeit more slowly, through the end of the year and into 2020.”
I can sum both up even further. Tariffs between the U.S. and China have increased manufacturing uncertainty and slowed activity in a late cycle economy, but probably (hopefully) not enough to take us into a recession in the short term.
Have a great Sunday!