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Market Insights: Surging leading indicators

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Surging Leading Indicators

Earlier this week, The Conference Board released its Leading Economic Index (LEI) in the U.S. for October with a much stronger than expected month over month gain of 1.2%. This is the largest monthly gain in four years and the biggest surprise relative to consensus expectation in seven and a half years. The sharp rise was driven by positive contributions from almost all of its underlying components. The strength in leading indicator subcomponents has become more widespread in the last six months compared to the previous six month period. The LEI also sits at an all-time high much like the U.S. stock market. 

Why is this important? The LEI is a widely followed composite of ten forward-looking components including building permits, new factory orders, and unemployment claims. The report attempts to predict general economic conditions six months out. 

We wanted to take this a bit further and discuss a less followed indicator of future growth, which is simply a variant of the LEI and another composite from The Conference Board called the Composite Index of Coincident Indicators (COI). As it sounds, it is a composite to gauge the current state of the business cycle. We are referring to the ratio of leading to coincident indicators (LEI/COI), which looks at how forward-looking indicators compared to current indicators.

We feel this is an even more useful and informative gauge than the LEI itself. When leading indicators are rising faster than coincident indicators, it signifies the economy is accelerating. With this month's release of data, the LEI/COI ratio has increased to 1.1222 which is the highest level of the recovery and current business cycle, and the highest level in over ten years. This definitely is noteworthy, but even more important is that the direction of this ratio is pointing higher.

Courtesy of Bespoke Investment Group, the following chart shows the ratio going back all the way to 1959, with recessions shaded in grey. This indicator has been a solid predictor of recessions as it has tended to peak about a year to a year and a half in advance of a recession. Although there have been a few instances where it has turned lower from a peak to move higher again, what is important to note is that there has never been a period where a recession has started when this ratio was rising. This would seem to indicate that a potential recession is likely at least another year, and likely more, away. Past peak levels for this ratio have been higher than where it is today, also indicating that a possible U.S. recession is still far away.

                           Source: Bespoke Investment Group