The Great Leading Indicator Smackdown
The Conference Board versus ECRI
The ECRI Weekly Leading Index (WLI) is an indicator I have tracked every Friday for the past few years, and I share my analysis here. I'm often asked why I haven't accorded the same attention to the Conference Board's index of Leading Economic Indicators (LEI). Henceforth, I will add the LEI to my routine updates. However, I should say at the outset that I believe LEI is too long and erratic in its lead to be a useful indicator of recession starts, although it has done an excellent job signaling the ends of recessions.
Here is a chart of the complete LEI series from the early days, when the index was reported by the Department of Commerce through its reincarnation in 1995 as a product of the Conference Board. I've also highlighted recessions as identified by the NBER.
A cursory glance reveals that the downward slope before recessions begins many months before recession starts, but the upturns coincide closely with the ends of recessions. Let's chart the data a different way to illustrate more precisely the lead time for this index in forecasting recessions. The next chart uses a simple Excel formula to plot months that set new highs at 100% and the other months by the percent of decline from the previous high.
The LEI has indeed begun declining in advance of all eight of the official recessions since its inception in 1959 — by the substantial average of 10.5 months and the wide range of 5 to 18 months. In contrast, the upturns coincide with the ends of recessions, often leading by a month or two.
ECRI Weekly Leading Index
Let's now compare ECRI's Weekly Leading Index with the Conference Board's LEI. I routinely follow ECRI's WLI Growth Index rather than the WLI. But for a comparison with the LEI, we'll focus on the WLI itself.
Downturns in the WLI also precede the onsets of recessions, and a percent-off-highs chart will document the degree of lead more precisely.
The callouts in the chart, of course, are in weeks rather than months, but the recession lead times for this index are, like the LEI, quite long, and the upturns are highly coincident with recession ends.
The key "difference maker" between Conference Board and ECRI is the Growth Index of the latter. The next chart features the WLI with the WLI Growth Index plotted below.
Here is a chart that zeros out the positive Growth Index data points in order to make a comparison with the two off-peak charts above. As we readily see, the Growth Index lead time before recessions shrinks considerably.
The one late call was the second part of the double-dip recession in the early 1980s. This was essentially a Fed engineered recession, an inevitable byproduct of Chairman Volcker's strategy to end stagflation by raising the Fed Funds Rate above 20%. It is a business-cycle anomaly that shows up as a late call in this chart and as a recession without an intervening new-high in the two percent-off-high charts above.
The Great Indicator Divergence
Throughout much of their history the ECRI WLI and Conference Board LEI have exhibited a reasonable degree of correlation, although the Growth Index, which ECRI mysteriously calculates from its WLI, has, in my view, given ECRI a distinct edge in making recession calls (see my note below for why I say "mysteriously"). The next chart is an overlay of the two. I've used a log y-axis to give precision to the slopes and vertical distances in the respective trends.
Note, however, that since the spring of 2010, the two indicators have exhibited a rather dramatic divergence. Beginning in April 2009, two months before the end of the last recession, the Conference Board's LEI index has set a new all-time high every single month — 31 and counting — with only two exceptions, June 2010 and April 2011. Their latest press release (LEI Rises Sharply) includes an optimistic forecast: "The LEI is pointing to continued growth this winter, possibly even gaining a little momentum by spring."
In contrast, as the adjacent chart illustrates, ECRI's WLI has trended down in two distinct waves since the end of April 2010. Last summer ECRI's co-founder, Lakshman Achuthan, denied that the first wave down in the Growth Index was signaling an imminent recession. However, in late September 2011, Achuthan announced, dramatically and categorically, that the US was tipping into recession, and that "there's nothing that policy makers can do to head it off."
What we have here is the Ultimate Indicator Smackdown — starkly conflicting views from two of the most widely followed centers of economic research on the fundamental question: "Where is the economy headed?"
I will post updates on how this divergence plays out over the months ahead, so we can all serve as referees to this smackdown.
Note: I called ECRI's growth index calculation "mysterious" because the Excel spreadsheet that ECRI shares with the public provides the historical data for both the WLI Level and the Growth Index — the latter presumably calculated from the former. However, the Growth Index in the spreadsheet consists of real numbers with 15 significant digits (the maximum supported in Excel), not a formula (e.g., the current week divided by a fixed previous interval week minus one). I've experimented with a variety of formulas to replicate the Growth series from the Level data — with no success.
See also Mike Shedlock's take on the latest LEI update: Leading Indicators or Statistical Noise?
Source: Advisor Perspectives
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