Long Train Running: Leading Indicators Show Little Risk of Recession

Key Points

  • April’s leading indicators posted another strong showing and continue to suggest little near-term recession risk.

  • Leading indicators have done a stellar job “forecasting” subsequent economic growth.

  • But leading indicators—which include the stock market—have done a less-than-stellar job forecasting subsequent stock market performance.

“Leaders aren’t born, they are made.” - Vince Lombardi

LEI history

In the 1960s, the U.S. Department of Commerce began researching and releasing business cycle indicators, which use composite data points—including manufacturing, construction and stock market indicators—to time economic cycle turning points. More than 20 years ago, The Conference Board took over the business indicator program from the government and created the Leading Economic Index (LEI), which was expressly designed to forecast recessions and subsequent recoveries.

Caveat: the LEI is not the be-all end-all. Upon its release each month, much of the data is a month or two old and nearly all of the 10 sub-components have already been released (or are available) prior to the release of the LEI itself. That said, the indicator has successfully rolled over in advance of each of the past five recessions; and also rolled up within recessions in advance of each of the past five recoveries.

As you can see in the chart below, not only is the LEI still improving, it’s improving at an accelerated pace. April’s reading was +0.4% with the prior month revised up to +0.4% from +0.3%. Eight of the 10 LEI subcomponents made positive contributions, led by the interest rate spread.

Recession risk low

Since the mid-1970s, the average span between a peak in the LEI and the start of the subsequent recession had been about 13 months. The dotted lines on the chart below show the spans of what I think of as the LEI’s “round trips” (from the peak in the prior cycle to the point when the LEI took out that prior high). This is when recoveries become expansions—when the leading indicators have recovered all of their recession-related weakness and move to new higher ground.

Leading Economic Index Accelerating

Source: Charles Schwab, FactSet, The Conference Board, as of April 30, 2018.