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Phil Green
Phil Green
author, misLeading Indicators: How to Reliably Measure Your Business

Greenbridge Management Inc.
President

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A leading indicator of business cycles that have already happened

Posted almost 8 years ago

A “leading indicator” is supposed to forecast, or at least to help the person using it, to make a forecast.

The Conference Board recently announced that it was changing its Leading Economic Indicator to address structural changes that have occurred in the US economy in the last few decades.  The new indicator was released on January 26, 2012.

In its press release,  the  Conference Board says “Revised figures show that adding the new Leading Credit Index™, in conjunction with other changes, makes the LEI a more accurate predictor of U.S. business cycles since 1990.”

A better predictor of business cycles since 1990? They have already happened.  That’s an interesting twist on economist Paul Samuelson’s famous 1966 quip that “Wall Street indexes predicted nine out of the last five recessions.” Now economists predict them after they happen. As physicist Niels Bohr said “prediction is very difficult, especially about the future.” It would be more convincing (to put it mildly) if they had revised the LEI before the last recession and made a prediction that turned out to be true. That would show that the indicator had some ability to “lead”.

The Leading Economic Indicator (LEI) is an index that combines ten indicators, including average weekly hours of manufacturing, average weekly unemployment insurance, new orders, building permits, stock prices and others.

In the new index there are changes such as removing the inflation-adjusted money supply and replacing it with a new Leading Credit Index. According to Kathleen Bostjancic, director of macro analysis at the Conference Board, the old index was being “skewed” by the money supply.

This blog post by Doug Short has a series of charts that compare the old and new indices from 1959 to today.  I’ve shown one of them below (the red line is the old LEI and the blue line is the new one). By superimposing the two indicators on the same chart, Short showed that the old and new indicators crossed paths in 1994, 2001 and 2008. The rest of the time they moved roughly in parallel, except in recessions. The difference between the two indicators is most dramatic before, during and after the 2008-2009 recession. The new LEI shows a much more dramatic drop in economic activity, and a much slower recovery.

Leading Econmic Indicators-Doug Short

Only time and experience will show whether the new LEI will be a better tool for forecasting economic activity than the previous one.  In the meantime, it is worth remembering an old lesson from some of the greatest scientists—just because you can obtain numbers from measuring does not mean the thing you think you are measuring actually exists.

And just because it is called a Leading Indicator does not mean it is.

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