One of the most commonly cited recession indicators that's been flashing red has a major flaw, NDR says

• The Conference Board's Leading Economic Index has declined for 20 consecutive months.
• Never has such a decline in the index happened without the economy going into a recession.
• Ned David Research explained why the commonly cited LEI indicator has "cried wolf."

One of the most commonly cited recession indicators is the Conference Board's Leading Economic Index, and it's been flashing red for nearly two years.

The forward-looking index has declined 20 months in a row, is down 12.6% from its peak two years ago, and is down 7.6% over the past year. The index has never seen such a sharp and persistent decline without an economic recession unfolding shortly thereafter.

But this time might finally be different as it appears the index has "cried wolf," Ned Davis Research said in a recent note. The firm highlighted why the economic index's perfect track record of warning about an imminent recession might have finally come to an end.

"The LEI may be another victim of pandemic related distortions," NDR said.

That's because the underlying components of the index weigh goods too heavily and services not enough. That's a problem when you consider that the makeup of today's economy is roughly 85% services.

"Five of the ten indicators are goods-related and three are financial-related," NDR explained. Only one component of the LEI captures the services economy, and that's unemployment claims.

The heavy reliance on goods-focused components is why the leading index failed to catch the sharp reacceleration in the US economy during the second half of 2023, in which GDP grew by about 5% in the third-quarter.

"The shift from goods to services this cycle has been well-documented," NDR said.

The goods-focused components of the LEI include consumer goods and materials orders, ISM New Orders Index, building permits, and consumer expectations for business conditions, all of which have moved lower from their early 2022 peak.

But at the same time, all of those components have been rising in recent months, albeit from depressed levels, NDR highlighted. That isn't enough to pull the LEI out of its rut, and that's unlikely to change unless more service-oriented components are added to the index.

"One day the economy will go into recession, but it won't be because of repeated warnings from the LEI. That will have to wait for a more normal economic cycle," NDR said.