Leading indicators point toward ongoing recovery

Doug May
Doug May

The Avant-Garde Advisors proprietary leading economic index (LEI) paused briefly in October, but remains in a longer-term upward trend that began in May.

During the most recent month, the number of indicators reporting improvement increased compared to a month ago. However, the magnitude of the decreases in the declining factors more than offset slight improvement in the  positive inputs. The weaker variables focused on the global economy, so it’s hard to blame the drop in the LEI to the federal government shutdown in the United States.

The Avant-Garde LEI was developed because the traditional leading economic index published by the Conference Board was overly sensitive to the massive easing in monetary policy engineered by the Federal Reserve. Since then, the Conference Board completely revamped its indicator. But at this point I’m still inclined to use our own proprietary model — which, I believe, incorporates inputs from a wider variety of industries.

Rock-bottom interest rates caused the Conference Board indicator to forecast a more robust recovery than the economy has actually experienced. The Avant-Garde indicator is designed to look through quantitative easing policies to determine the actual effects of policy on key sectors of the economy. The traditional LEI indicates a much more robust rebound than employment statistics appear to reflect.

In spite of the October government shutdown, such key sectors as retail sales, corporate profits and  new orders for manufactured goods remain strong. On the other hand, the self-made crisis in Washington appeared to dampen small business optimism. Small business owners remain hesitant to expand operations, causing a severe drag on job growth. Drilling activity is also weaker than was the case a year ago. Meanwhile, shipping prices offer an indicator of global export activity. After rising significantly in September — probably based on global worries about war in Syria — shipping prices fell in October.

While the preliminary numbers for October reflected a decline in economic activity, I’m hopeful the increase in the index since April will continue. Typically, investors don’t need to worry unless there are at least three consecutive months of decline in the index. The longer term trend is still higher, which forecasts an ongoing recovery for the next six months.

The past is not necessarily prologue, of course, but single-month declines in the midst of a long-term rising trend are fairly common. The leading index shows the economy growing rapidly in 2010 and 2011, coming out of the deep trough which accompanied the 2008 financial crisis. The indicator has been fairly stable for the past two years.

Declines in the indicators in 2011 and 2012 were associated with dysfunctional partisan budget negotiations in Washington. After these periods of self-induced hysteria pass, the economy normalizes. It’s good to see the economic index climbing higher despite the foolish intransigence exhibited by politicians in Washington. It’s somewhat reminiscent of the days of old, when markets followed economic trends instead of political cat fights. Maybe we’re making progress after all.