Conference Board LEI: Recession Signal Reignited

  

Introduction

Stock investors have a lot on their plate. They need to forecast individual companies' revenues and profits, deepen their understanding of the industries target companies belong to, and sometimes conduct macroeconomic analysis on the global economy. Even focusing on just one of these tasks involves an overwhelming amount of information to absorb. Recently, concerns about a slowdown or recession in the U.S. economy have sparked more interest in macroeconomic analysis than before.

Serious investors need to track various macro indicators such as the U.S. monthly employment report, weekly unemployment claims, wage growth rates, CPI/PPI data, GDP growth rates, and even the yield curve between short-term and long-term interest rates.

The challenge lies in how these indicators often send mixed signals. For example, while the Manufacturing PMI might suggest an economic contraction, the Service PMI may indicate expansion. Likewise, the slowdown in CPI growth may imply a cooling economy, yet hourly wages may still be on the rise, indicating a hot economy.

There's a lot to monitor, but how to synthesize these differing statistics is also a major issue. Have you ever thought, "Forget it, just give me one number that comprehensively summarizes all key economic changes and tells me at a glance whether the economy is improving or worsening?"

Conference Board Leading Economic Indicator®

That’s exactly the idea behind the Conference Board Leading Economic Index (LEI). The Conference Board (CB) is an American NGO, and the LEI aggregates 10 key economic indicators that have historically shown predictive power, aiming to forecast the future direction of the U.S. economy. Let’s take a look at the 10 components of the LEI:

1. Average weekly hours in manufacturing  
2. Average weekly initial claims for unemployment insurance  
3. Manufacturers' new orders for consumer goods and materials  
4. ISM Index of New Orders  
5. Manufacturers' new orders for nondefense capital goods, exclg aircraft
6. Building permits for new private housing units  
7. S&P 500 Index  
8. Leading Credit Index™  
9. 10-year Treasury bonds less federal funds rate  
10. Average consumer expectations for business conditions  

The 8th indicator, the Leading Credit Index™, is itself made up of six financial indicators, so one could argue that the LEI is actually composed of a total of 15 indicators. The weight of each component is periodically adjusted, but unfortunately, the exact weights are not disclosed. Still, you would think that combining this many economic indicators would yield a powerful predictive tool.

Success Rate of the LEI in Predicting Recessions

The chart below shows the Conference Board’s LEI (blue line) and real GDP (red bar chart, inflation-adjusted) from 1980 to the present. The gray areas represent periods of recession in the U.S., so let’s see if the LEI correctly predicted these recessions.

Source: https://en.macromicro.me/charts/53/leading-gdp

There have been five recessions since 1980, and in all five cases, the LEI turned negative before the recession began. That seems fairly reliable, doesn’t it? But hold on, isn’t something a bit strange? The LEI turned negative in July 2022 (-0.26%), and it’s been negative for more than two years now. While there’s been ongoing debate about a  potential recession, it hasn’t landed yet. How long after the LEI turns negative should we expect a recession?

Time from LEI Peak to Recession

Source: Vettafi, https://www.advisorperspectives.com

The graph above shows how long it took for recessions to follow after the LEI peaked, going back to 1959. On average, recessions arrived 10.6 months after the LEI’s peak across eight different cases. But now, 32 months have passed from the latest LEI peak without a recession, which is much longer than the longest previous delay of 20 months during the 2008 recession. However, the Conference Board uses a different calculation method to signal recessions. Let's see. 

Recession Signal Back On in August

The graph below is directly analyzed by the Conference Board. It indicates a high likelihood that a recession is imminent or already underway when two conditions are met, which are represented by the red horizontal line. The two conditions are: (1) the six-month diffusion index is 50 or below, and (2) the six-month decline rate of the LEI is below -4.4%. The diffusion index quantifies how many of the 10 components of the LEI are weakening; the lower the index, the more components are deteriorating.

Source: https://www.conference-board.org/topics/us-leading-indicators

However, it’s been some time since the recession signal (the red line) first appeared in the second half of 2022. To be precise, the recession signal briefly moved above the threshold of -4.4% in March 2024, but in the latest data released for August, it has fallen below that threshold again, turning the recession signal back on.

Conclusion

Should we now disregard the Conference Board’s Leading Economic Index®, which no longer seems to work? Experts give various reasons why the recession signal isn’t matching this time. These include the unprecedented disruption from the COVID-19 pandemic, which significantly altered the historical patterns of key indicators such as employment, new orders, and credit that make up the LEI; the expansion of the gig economy, which has changed the relationship between the economy and employment; or simply that the arrival of an actual recession is delayed this time.

But if the LEI no longer forecasts an economic slowdown or recession in advance, is it still worth following? Or is a recession coming soon, potentially worsened by the length of the delay? I don’t have an answer to that. Perhaps by the end of next year or the following year, we’ll have a clearer view. With experts sharply divided and previously reliable indicators now less useful, the best approach seems to be considering multiple economic scenarios and investing based on the probabilities of each scenario.

Thanks for reading. I wish you success in making smart investments!

This blog does not offer investment, financial, or advisory services. The information provided herein is for general informational purposes only and should not be interpreted as advice for making specific investment decisions. All investments involve risk, and past performance is not indicative of future results. It is advisable to consult with a qualified financial advisor to determine strategies or products that are appropriate for your individual circumstances. The owner, writer, or operator of this blog accepts no responsibility for any direct or indirect losses that may arise from the use of or reliance on the content presented. The information provided on this blog is subject to change and may not be current. The content is based on personal opinions, as well as information from news sources and research, and may vary due to shifts in personal opinions, financial market conditions, or other influencing factors. Most data referenced is derived from daily closing prices. Data finding, sorting, graphing, and analysis are performed primarily by myself, and while efforts are made to ensure accuracy, errors may be present. If you identify any inaccuracies, please inform me via comments or email, and I will endeavor to review and correct them as necessary. External content or images will be cited to the best of my ability.