LEI - Slower Growth Of The Growth Update
The Leading Economic Indicator (LEI) was released yesterday with little fanfare. The leading index for the U.S. increased 0.3 percent in March to 95.7 (2004 = 100), following a 0.7 percent increase in February, and a 0.2 percent increase in January. As it has often been in the past the Fed's zero-rate policy, by the spread between short and long rates, has boosted the index due to the large weighting of this one component. Also, the first quarter surge in the stock market, also heavily weighted, has boosted the index as well. Building permits and unemployment claims which have been supportive recently may become net drags in the future months as the warm weather effect that we addressed in the last update begins to fade.
The first chart shows you the LEI index as reported. While the media quickly noted its improvement the reality is that it really doesn't tell you much. The index does tend to lead recessions but doesn't provide much advance warning. Therefore, one way to strip out some of these anomalies is to view the data on a year-over-year basis. If we look at LEI on this basis we find that growth rate of the LEI has slowed dramatically. After LEI peaked in April of 2010, as the first round of QE was coming to an end, it has been on a steady decline even with the recent signs of economic improvement. Even the subsequent rounds of stimulus from QE 2 and "Operation Twist" have had little effect on reaccelerating underlying economic strength.
While those subsequent rounds of liquidity injections have fueled stock market speculation it has done little to actually boost the real economy. The current decline in the year-over-year growth rate of the LEI has always tracked very closely to the ebb and flow of the "real" economy. While the LEI is not indicating a recession currently, the slope and magnitude of the decline are definitely cause for concern about pending economic weakness. The reason is that, outside of the seasonal effects, the economy got a boost in demand post the Japanese earthquake last March. That shut down in production, combined with the debt ceiling debacle during the summer, created a vacuum in the manufacturing sector and a bleed down in inventories. This fulfillment of pent up demand and inventory restocking has now run its course given the sharp decline auto sales last month.
We can find further confirmation of weakness in the overall economy if we look at the ratio between the Conference Board's coincident and lagging indicators. This acts like a book-to-bill ratio for GDP. Currently, it is off of its peak by about 2% and at levels that have normally coincided with recessions in the economy.
While the current month to month data points are still indicative of growth - the concern is strength of that growth. With the underlying economy fragile and very susceptible to external shocks it will not take much to create a retrenchment. If this was truly not the case the Fed would not be holding the line at zero interest rates and floating hopes of continued asset purchases (QE) in the future. Now, with China slowing more rapidly than expected and Europe continuing to slide, the ability for the U.S. to withstand that drag indefinitely is negligible. As the seasonal weather patterns return to normal ranges, along with the data skews, we will get a much better picture about where the economy currently stands.
It is important to look beyond the headline numbers and the monthly data points. As always economics is about changes at the margin which is easily masked by the discussion of specific data points without providing some sort of comparative analysis. As my father always said: "You can't know where you are going if you don't know where you came from." While he was not an economist - he had the right idea. Invest accordingly.