Many stock investors search high and low for the holy grail of economic enlightenment – a guiding light that can deliver a full economic snapshot in a single number. While The Conference Board Leading Economic Index® (LEI) doesn't exactly qualify as a holy grail, and it is doubtful that there is such thing as the perfect indicator, the LEI can offer investors and traders a potentially advance warning signal on recessions. Each month the board crunches a number of economic variables to calculate its LEI. The latest data revealed a 0.2% increase in September to 124.4.
"Historically, the LEI has turned down before the economy has turned down," says JJ Kinahan, chief market strategist at TD Ameritrade. The latest positive LEI reading may reveal "the economy is heading in the right direction," Kinahan says.
Investors may be interested to know that stock prices are one of the components of the LEI. Analysts generally believe that the stock market in and of itself is a leading indicator for the economy as it typically leads the business cycle by 6-9 months. This means that the stock market generally may turn down months before a recession hits.
Sam Stovall, chief investment strategist at CFRA, agrees that the LEI can offer valuable insights. "I find that a six-month percent change in LEI has been a fairly reliable indicator of economic recession," Stovall says. "Every recession was preceded by a decline in a rolling 6-month percent change LEI." See Figure 1 below.
However, as traders searching for the holy grail may have found, no indicator is perfect. "The LEI is not foolproof. Not all declines in the LEI led to recession," Stovall says.
What Does the LEI Signal Now?
Housing permits, unemployment insurance claims, and the interest rate spread were the main components lifting the index in September.
"The indicators are not signaling robust economic growth at full speed ahead, but it's not pointing lower," Stovall says. "Bull markets don't die of old age –they die of fright. What are they most afraid of? Recession. Right now, we don't see any clues indicating a recession," Stovall says.
Looking ahead, CFRA forecasts a 12-month target in the S&P 500 at 2250, which is roughly 5% above current price levels, Stovall says. "A 5% price gain in the coming 12-months is not great, but it's not negative," Stovall concludes.
The LEI components for the U.S. include:
1. Average weekly hours, manufacturing
2. Average weekly initial claims for unemployment insurance
3. Manufacturers’ new orders, consumer goods and materials
4. ISM® Index of New Orders
5. Manufacturers' new orders, nondefense capital goods excluding aircraft orders
6. Building permits, new private housing units
7. Stock prices, 500 common stocks
8. Leading Credit Index™ Interest rate spread, 10-year Treasury bonds less federal funds
9. Average consumer expectations for business conditions
TD Ameritrade clients can track the LEI data using thinkorswim®. See Figure 2 below.