Predict Future Economic Activity

The ability to predict future economic conditions is useful in business, business planning and investment. Turns out there’s a pretty easy, inexpensive and reliable method for doing so — at least for short-term forecasts of less than a year.

Check out the chart below. It displays the historical index of leading indicators compiled and published by e-forecasting.com. The gray bars are recessions. As you can see, the index tends to dip in the months prior to a recession and rise before the end of the recession and through the expansion. Economists have identified economic data that tend to positively correlate with future economic conditions. That is, changes in these indicators tend to precede changes in overall economic activity.

Leading Economic Indicator Index

The federal government (Conference Board) has settled on 10 so-called leading indicators. It tracks them and publishes the data monthly. Possibly more useful is the index of leading indicators, similar to the one compiled by e-forecasting.com. An index is a compilation of indicators. You can view the federal government’s index of leading indicators at www.conference-board.org/data. You also can sign up to receive email alerts when new data are released.

Here are the 10 indicators used and tracked by the federal government:

Money supply (M2)

When the money supply does not keep pace with inflation, bank lending may fall in real terms, making it more difficult for the economy to expand. M2 includes currency, demand deposits, other checkable deposits, travelers checks, savings deposits, small-denomination time deposits and balances in money market mutual funds. The inflation adjustment is based on the implicit deflator for personal consumption expenditures. This data set is given the largest weight in the overall LEI index, a full 35.8 percent.

Average weekly hours, manufacturing

The average hours worked per week by production workers in manufacturing industries tend to lead the business cycle because employers usually adjust work hours before increasing or decreasing their workforce. This data set is given the second largest weight in the overall LEI index — 25.5 percent. For current and recent historical average wage data

Interest rate spread, 10-year Treasury bonds less federal funds

The spread or difference between long and short rates is often called the yield curve. This series is constructed using the 10-year Treasury bond rate and the federal funds rate, an overnight interbank borrowing rate. It is felt to be an indicator of the stance of monetary policy and general financial conditions because it rises when short rates are relatively low (high). When it becomes negative (i.e., short rates are higher than long rates and the yield curve inverts), its record as an indicator of recessions is particularly strong. This data set is given the third largest weight toward the overall LEI index, 9.9 percent.

Average weekly initial claims for unemployment insurance

The number of new claims filed for unemployment insurance is typically more sensitive than either total employment or unemployment to overall business conditions, and this series tends to lead the business cycle. It is inverted when included in the leading index; the signs of the month-to-month changes are reversed because initial claims increase when employment conditions worsen (i.e., layoffs rise and new hiring falls). For current and recent historical initial claims for unemployment, see the graph below.

Manufacturers’ new orders for consumer goods and materials

These goods are primarily used by consumers. The inflation-adjusted value of new orders leads actual production because new orders directly affect the level of both unfilled orders and inventories that firms monitor when making production decisions.

Manufacturers’ new orders, non-defense capital goods

New orders received by manufacturers in non-defense capital goods industries (in inflation-adjusted dollars) are the producers’ counterpart to the consumer orders index, above.

Index of supplier deliveries — vendor performance

This index measures the relative speed at which industrial companies receive deliveries from their suppliers. Slowdowns in deliveries increase this series, and they are most often associated with increases in demand for manufacturing supplies rather than negative shocks to supplies. This index, therefore, tends to lead the business cycle. Vendor performance is based on a monthly survey conducted by the Institute for Supply Management that asks purchasing managers whether deliveries from their suppliers have been faster, slower or the same as the previous month. The slower-deliveries diffusion index counts the proportion of respondents reporting slower deliveries plus one-half of the proportion reporting no change in delivery speed.

Building permits, new private housing units

The number of residential building permits issued is an indicator of construction activity, which typically leads most other types of economic production.

Stock prices

The Standard & Poor’s 500 stock index reflects the price movements of a broad selection of common stocks traded on the New York Stock Exchange. Increases (decreases) of the stock index can reflect both the general sentiments of investors and the movements of interest rates, usually another good indicator for future economic activity.

Index of consumer expectations

This index reflects changes in consumer attitudes about future economic conditions and, therefore, is the only indicator in the leading index that is completely expectation-based. Data are collected in a monthly survey conducted by the University of Michigan’s Survey Research Center. Responses to the questions about various economic conditions are classified as positive, negative or unchanged.

If you are unsure about where the broader economy is headed, it might make sense to check an index of leading indicators. The U.S. Conference Board is the most widely used. Other private indexes, such as the one compiled by e-forecasting.com, also should provide reliable data that can help you decide when to invest for growth and when to pull back.