Federal Open Market Committee’s impact on investments this week

Part 4
Federal Open Market Committee’s impact on investments this week (Part 4 of 7)

How the S&P 500 Index high impacts leading economic indicators

The Conference Board’s index of leading economic indicators

The Conference Board’s monthly releases of leading, lagging, and coincident indicator indices give important clues to the direction the economy is headed. May’s report is due for release on Thursday, June 19. The Leading Indicators Index (or LEI) has increased over the past three months, primarily driven by the spread between ten-year Treasuries (IEF) and the Fed funds rate.

In April, another leading indicator, housing starts also showed improvement, spurring the LEI to a 0.4% increase in April. Housing starts are an important leading indicator, with multiplier effects throughout the economy. An improvement in this indicator would imply future economic growth. Housing starts would benefit companies like Lennar (LEN) and PulteGroup (PHM). Investors can gain exposure to these companies by investing in the State Street SPDR Homebuilders ETF (XHB). LEN and PHM are part of the top ten holdings in XHB.

Part 4Enlarge Graph

Indicators that made negative contributions to the LEI 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 last month.

Outlook

There should be improvement in some components of the LEI this month, most notably durable goods orders and stock market contribution. Durable goods orders recorded a higher-than-expected 0.8% increase over March, compared to market expectations for a decrease of -0.8%. Durable goods orders are key to economic growth because they impact production levels in other industries as well. In response to the consensus beating numbers, the S&P 500 Index (VOO) reached a new high of 1911.91 on May 27, increasing by 0.6%. The S&P 500 Index has risen by 2.1% in May, reaching a record high of 1923.57 on May 30.

However, initial jobless claims have fluctuated in May, although they’ve shown a net decline at the end of the month. Labor indicators may still prove to be a drag on the LEI.

About the Conference Board’s LEI

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.

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