Leading Economic Indicators
Are We Headed Into Another Recession? Check These Indicators First
Leading economic indicators are statistics that precede economic events. They predict the next phase of the business cycle. That becomes critical when the economy is either coming out of a recession or heading into one. Leading indicators are the first data point in an economic trend. Coincident indicators occur next, followed by lagging indicators. They either confirm or refute the trend set by leading indicators..
List of Top Five Leading Economic Indicators
The Durable Goods Orders Report tells you when businesses order new big-ticket items. Examples are machinery, automobiles and commercial jets. Why is this important? When the economy weakens, companies delay purchases of expensive new equipment. They'll just keep the old machines running to save money. The first thing they do when they regain confidence about the future is to buy new equipment. This isn't the same as consumer purchases of durable goods, such as washing machines and new cars. That's important, but business orders pick up first when a downturn ends.
Interest rates are the most important indicator for the average person to follow. That's because falling and low interest rates create liquidity for businesses and consumers. That means money is cheap, and both are more likely to buy as soon as the economy improves. When interest rates rise, you know the economy will slow down soon.
That's because it costs more to take out a loan, making everyone buy less.
The stock market is a good predictive indicator. Investors spend all day, every day, researching the health of businesses and the economy. When stock prices rise that means they are more confident in future growth. When the stock market falls, it mean investors are rushing toward traditional safe havens.
They'll sell stocks and buy as 10-year Treasury notes and gold. Pay particular attention to the Dow Jones Utility Average. It measures the stock performance of utilities. These companies have to borrow a lot to finance their expensive energy generation facilities. As a result, their earnings are dependent upon interest rates. When rates are down, their earnings are up, and so is the utility index.
The number of manufacturing jobs tell you manufacturers' confidence level. Although headline employment is a coincident indicator, factory jobs are an important leading indicator. When factory orders rise, companies need more workers. That benefits other industries like transportation, retail and administration. When manufacturers stop hiring, it means a recession is on its way.
Building permits give you a nine-month lead in new home construction. Most cities issue the permit two to three months after the buyer signs the new home sale contract. That's usually six to nine months before builders complete the new home. When permits start to fall, it's a clue that demand for new housing is also down. When that happens, it usually also means something is wrong with the resale market. Real estate is a significant component of the economy, as are construction jobs.
When this sector weakens, everyone feels it.
For example, economists made that mistake in the last recession. They thought the housing slump would be contained within real estate. As early as October 2006, building permits for new homes were already down 28 percent from the year before. It was an early sign of the subprime housing crisis, which became a global financial crisis by 2008. Housing construction fell as a component of gross domestic product. It contributed 6.1 percent to economic output in 2005. It fell to just 2.2 percent in 2011.
Index of Leading Economic Indicators
The U.S. Conference Board publishes an index that measures these and other leading indicators. The Board is a private nonprofit corporation. It's under contract with the federal government to release these and other indices.
They aren't as good at predicting economic trends for reasons outlined below. The Index includes:
- Money Supply - This doesn't take into account money invested in stock or bond funds. They also affect liquidity. The Fed's interest rate moves immediately impact the money supply.
- Consumer Expectations - This is based on a survey of consumers. It asks for their future expectations, but they depend on the unemployment rate. That's a lagging, not leading, indicator.
- - Investors use this report to predict the monthly nonfarm payroll report (jobs reports). But it measures unemployment, which is a lagging indicator. It doesn't predict what the economy will do next.