Follow the Leading Indicators

Investors, economists and policy makers are always looking for tea leaves that will forecast the future to mitigate risk. Leading indicators, by definition, are meant to forecast trends before they become readily apparent. In the 1960’s the US Department of Commerce developed a set of 10 Leading Economic Indicators known as the LEI to time business cycle expansions and Recessions. Since the non for profit Conference Board took over as the de facto disseminator and chief of the LEI crystal ball, this index has become popular and is now provided for 12 countries. Like most crystal balls in the real world, its viewing can be a bit cloudy at times or too late to help stock investors. However, the LEI has impressively turned lower well before every economic Recession. Sometimes the LEI downturns can slightly lead to the onset of a major correction in the stock market or at least provide confirmation that a serious Bear market decline is underway. Also useful for investors is the confidence in Buying major panics in the stock market that are unconfirmed by these leading indicators. When the black crash of 1987 hit, triggering a quick 35% wipeout of the stock market for no economic reason, the LEI continued to hit new highs, paving the way for vigilant investors to buy. There were four more times between 1998 and 2018 where stock indices fell over 20%, hinting of a major economic contraction. Yet each of these times that stocks cratered, the LEI Bullishness should have reassured longer term investors to buy hand over fist into these declines.

In the months prior to the Covid crash the flat LEI actually hinted there was economic trouble brewing. The Covid induced global lockdown quickly sent all of the LEI components into a brief contraction which was immediately reversed by massive stimulus. The steep rise in the index over the past 18 months portrays an economic engine running hot, but being flooded with too much gas. The growing unfulfilled demand due to product shortages and labor shortfalls are choking the delivery supply chains. Despite the lack of products to buy, nine of the ten LEI components are economic measurements and all are rising. The lone warning flag in this Leading Index is a consumer sentiment metric that has been falling to multi-month lows as of September. The sharp decline in Conference Board and Michigan consumer expectations are likely due to concern over the Covid wave of Delta surge. Since this September data was surveyed, Covid fatalities have fallen sharply and consumers are still spending heavily. Thus the lone LEI caution flag may be less important than normal.

Income level is also a factor in how population groups react to the Covid recovery. Wealthy consumers are most optimistic as travel restrictions ease and their stock portfolios soar. With air travel still 25% lower as of today vs this date in 2019 (prew Covid) and with millions of workers still choosing to stay home, we clearly need to drive Covid fatalities lower and remove virus fears before labor dependent supply chains normalize and inflation recedes.

As long as the feared supply chain shortages of fuel and food don’t manifest this winter, the economy and stock market can continue rising. The record delay in delivery times and chip shortages due pose risk for profit margins, especially among premium priced major tech companies in this 4th quarter, even though excess investor cash on the sidelines may continue to funnel into equities overall. Longer term, investors should keep an eye on the Leading Economic Indicators for signs that this artifically stimulated global recovery is ready to roll over.


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