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A trusted indicator is fueling recession warnings from Jeremy Grantham and other gurus. What you should know about the Leading Economic Index.

Feb 21, 2024, 19:04 IST
Business Insider
MJgraphics / Shutterstock
  • The Leading Economic Index brings together data on stocks, housing, credit, jobs, and sentiment.
  • The trusted recession indicator has declined for 22 consecutive months through January.
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A recession indicator with a stellar track record has been flashing red for nearly two years now, fanning fears that the economy is falling into a slump.

The Leading Economic Index fell for the 22nd consecutive month in January. It dropped by 3% between July and July, after slumping 4.1% over the preceding six months.

Here's a closer look at the early-warning system, and why it's worrying several top investors and economists.

Looking into the future

The index signals peaks and troughs in the economy's boom-bust cycle, typically seven months ahead of time.

The index is published by a non-profit think tank called The Conference Board. It heralds changes in growth, employment, consumer spending, business investment, and other economic data by pulling together 10 indicators:

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  • The S&P 500 index

  • The Leading Credit Index

  • The interest-rate spread (10-year Treasury bond yield minus the federal funds rate)

  • Average weekly hours of manufacturing workers

  • Manufacturers' new orders for consumer goods and materials

  • The Institute for Supply Management's index of new orders

  • Manufacturers' new orders for non-defense capital goods, excluding aircraft

  • Average weekly initial applications for unemployment insurance

  • Building permits for new private housing units

  • Average consumer expectations for business conditions

All 10 data points help to gauge the future direction of the economy. For example, the S&P 500 prices in the stock market's projections for corporate profits and economic growth, meaning the benchmark index often moves in advance of good or bad things actually happening.

The interest-rate spread indicates where Wall Street expects rates to be in the coming years, and whether it expects a recession. The Leading Credit Index looks at debt-related data — like the scale of margin lending and expectations of future borrowing conditions — to get a sense of the economy's financial health down the line.

Changes to workers' weekly hours and unemployment claims speak to the level of labor-market demand, and whether joblessness is likely to rise or fall in the months ahead.

Order volumes indicate whether consumer spending and business investment are waxing or waning. Tracking building permits helps to measure the scale of construction activity and housing demand. And surveys that measure consumer and business confidence are useful in predicting future spending and investing.

The Leading Economic Index brings all of those together to gauge the future state of the economy across multiple dimensions, from growth and unemployment to consumer demand and homebuilding.

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Here's a screenshot showing the index's historic decline, from The Conference Board's latest release:

The Leading Economic Index has consistently declined ahead of previous recessions.The Conference Board

Bear fodder

Several high-profile bears have held up the index's prolonged slump as strong evidence that a recession is coming despite the US economy's recent strength.

"We simply never see a string of declines like this without seeing a recession," David Rosenberg, president of Rosenberg Research and the former chief North American economist at Merrill Lynch, said in a research note last year.

Jeremy Grantham, a bubble expert and GMO's long-term investment strategist, told Business Insider late last year that the index's protracted slump was bad news for stocks and the economy.

"The leading indicators have been declining forever, and they're in dreadful shape, and they have been predicting that we will have a fairly usual end to a great bubble that's taking its time," he said.

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Jeffrey Gundlach, the billionaire CEO of DoubleLine Capital, recently flagged that the index's "very negative" trajectory pointed to an oncoming recession.

Similarly, the legendary forecaster Gary Shilling recently told Business Insider that the index's steady slide was one of the "classic signs" of a recession, which he predicted would hit this year.

There's no guarantee these four market veterans are right about the Leading Economic Index. Other experts have criticized it for being too weighted toward manufacturing in an increasingly service-oriented economy, and dismissed its relentless decline as a product of pandemic distortions.

Moreover, the Conference Board itself said the index is no longer signaling a recession, as six of its 10 components improved in the six months through January. But the group still predicted real GDP growth would stall to virtually zero in the second and third quarters.

Even so, the index's past accuracy in anticipating recessions means it's very much worth monitoring.

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