Danger Signs on the Economy

Last Thursday the October reading for the Leading Economic Index (LEI) was released and it showed a decline of 0.1% for the month. Such a small decline doesn’t seem like a big deal, but it was the third straight monthly decline for the indicator and the September reading was adjusted downward from -0.1% to -0.2%. The cumulative decline over the last three months is -0.5% and that erased the 0.4% increase in July.

There are a couple of different ways the LEI is viewed as a recession indicator. Some economic experts view three straight months of declines as a sign of an impending recession. Others believe that you have to look at the cumulative total. If the total reaches -1.0% in a six-month period, that is an indication that the economy is headed for a recession.

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Of course, there is some leeway in how long it takes for the recession to start after these warning signs are triggered. Just like we have seen with inverted yield curves, the lag time can vary. The following chart is from Advisor Perspectives and it shows the six-month moving average of the six-month rate of change. It also lists the lead times before the recessions hit.

As for the inputs that go into the LEI, there are 10 of them:

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders, consumer goods and materials
  • ISM® Index of New Orders
  • Manufacturers’ new orders, nondefense capital goods excluding aircraft orders
  • Building permits, new private housing units
  • Stock prices, 500 common stocks
  • Leading Credit Index™
  • Interest rate spread, 10-year Treasury bonds less federal funds
  • Average consumer expectations for business conditions

This is yet another indicator that is pointing to potential problems for the economy as we get ready to start 2020. Of course, we had the inverted yield curve which is widely followed as a recession prediction tool. There is also the Consumer Confidence Index. The reading for November was released earlier today and it came in at a reading of 125.5 for the month. The reading was down from 126.1 in October and it marked the fourth straight monthly decline in the indicator. The 2019 peak came in July at 135.8, but the peak for this economic expansion came at 137.9 in October 2019. I have written several articles about the Consumer Confidence index and how when the indicator peaks and then falls by at least 10%, it becomes a concern about the economy.

There is also the ISM Manufacturing Index which has been on a steady decline throughout 2019 with the last three months coming in below the 50 level. The 50 level is the demarcation point between expansion and contraction, so seeing three straight readings of contraction is an obvious concern.

Not all economic indicators are pointing to a recession, but enough of them are that we should definitely be taking precautions with our investment portfolios. Like I said before, the lag time between when these warnings signs flash and when an actual recession hits can vary by as much as a quarter or two to as much as over a year.

With the GDP still growing and with the unemployment rate at a multi-decade low, it is easy to dismiss the lesser followed indicators that are pointing to a possible recession. I am not suggesting that investors should dump their entire stock portfolio and move into other asset classes, but I am suggesting that investors need to pay attention to the number of indicators that are starting to point to a lagging economy in 2020.

Personally, I have Bloomberg TV on almost all day and I have been hearing so many analysts come on and talk about how this time is different. In my experience, when we start thinking that things are different this time around, that turn out to be just like they were in the past. When inverted yield curves suggest a recession is on the horizon, more times than not there has been a recession. When the LEI falls for three straight months or declines by a cumulative 1% over six months, a recession follows more times than not.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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