Must-know: Leading economic indicators—economic growth may approach 3%
Conference Board’s leading economic indicators rise for third consecutive month
Each month, the Conference Board releases its indices of leading, lagging, and coincident indicators, which give important indications to the direction the economy is headed. The Leading Indicators Index (or LEI) has increased over the past three months, which indicates that the U.S. economy is poised for growth. In April, the LEI increased by 0.4%—lower than March’s unexpectedly large 1% gain.
“The LEI rose for the third consecutive month, driven largely by improving housing and financial market conditions,” said Ataman Ozyildirim, economist at The Conference Board. “This latest report suggests the economy will continue to expand, and may even pick up steam through the second half of the year.”
Interested in FLOT? Don't miss the next report.
Receive e-mail alerts for new research on FLOT
Financial market indicators make up two of the ten indicators included in the LEI. The spread between the Fed funds rate and 10-year U.S. Treasuries (or UST), is one of the most important leading indicators. Once again, the spread was the largest component accounting for the increase in LEI, pointing to economic growth in the coming months. The Leading Credit Index, which is a composite of six different financial indicators, also increased, making a positive contribution to the LEI.
Housing market improvements, represented by building permits, also made strong gains in April. This reversed the negative contribution made in March. Building permits increased by 8% in April, month-over-month. The increase was primarily due to an increase in permits for multi-family homes, which rose by 19.5%. This trend would impact companies like Lennar (LEN) that engage in construction of residential apartment buildings. Investors can invest in LEN through the iShares U.S. Home Construction ETF (ITB), which tracks the performance of the Dow Jones U.S. Select Home Construction Index.
Indicators making negative contributions included the labor market indicators (average work week and initial jobless claims) and durable goods orders. Stock price performance didn’t significantly impact the LEI. The contribution of stock market performance, represented by the price performance of companies included in the S&P 500 Index (VOO), was flat. Average consumer expectations for businesses increased the LEI marginally.
“Despite a brutal winter which brought the economy to a halt, the overall trend in the leading economic index has remained positive,” said Ken Goldstein, economist at The Conference Board. “If consumers continue to spend, and businesses pick up the pace of investment, the industrial core of the economy will benefit and GDP growth could move closer towards the 3% range.”
An uptick in consumer spending and economic activity is usually accompanied by an increase in interest rates, all else equal. As bond prices move inversely to interest rates, this would unfavorably impact the prices of ETFs that are long-fixed income securities. Investors can benefit from rising rates by investing in floating rate ETFs like the VanEck Vectors Investment Grade Floating Rate ETF (FLTR) and the iShares Floating Rate Bond ETF (FLOT). For more on floating rate securities, please read the Market Realist series, Why investors should look at floating rate notes as an option.
About the Conference Board’s leading indicator index
The Conference Board’s three indices of leading, coincident, and lagging indicators give an estimate of the peaks and troughs of business cycles. Each of the three indices are based on indicators that are categorized as leading, lagging, or coincident. These indices are designed to summarize and indicate key turning points in business cycles. An increase in the LEI would mean that economic activity is likely to accelerate in the coming months, while a decrease in the LEI would indicate the opposite.
What are leading, lagging, and coincident indicators?
A leading indicator is one that is generally thought to precede changes in economic activity, while a lagging indicator usually follows changes in economic activity. A coincident indicator is one that usually accompanies changes in economic activity. The LEI is based on readings from ten leading economic indicators, while the Coincident Economic Index (or CEI) is based on readings from four coincident economic indicators. The use of numerous indicators in constructing indices would smooth out some of the volatility of individual indicators, if they were taken in isolation.
The next section of this series will cover the Chicago Fed’s National Activity Index. Please read on.