Monday, January 30, 2012

A less-brave, new LEI

The Conference Board updated this month the composition of its Leading Economic Indicators index. The most important change was the substitution of M2 for a proprietary index of credit conditions. Over the last year, especially, it had become embarrassingly evident that M2 was pushing the LEI up, and that this was not justified by economic conditions. M2 accounts for almost a quarter of the index. Now that the Conference Board has replaced M2 with a more appropriate proxy for credit conditions, the LEI is a lot closer to pointing to a near-term recession than it was before.

Source: John Hussman.

It is not yet clear whether the LEI has reached a cyclical peak, or whether it's just taking a breather. (I, of course, think it's the former.) The six-month change of the index, for instance, is now in negative territory. Historically recessions have always been preceded by a negative six-month change of the index, although there have been instances where such negative change has not been followed by a recession. I have taken the three-month moving average of the LEI (LEI-3MA), in order to remove some of the short-term noise, and then calculated the six-month percent change, annualized, of that moving average. These are the true and false positives of this signal:

Aug. 69: True positive. Recession started in Jan. 70. Avg. value in the three months before recession start: -4.2%

Aug. 73: True positive. Recession started in Dec. 73. Avg. value in the three months before recession start: -5.1%

Mar. 79: True positive. Recession started in Feb. 80. Avg. value in the three months before recession start: -8.2%

Mar. 81: True positive. Recession started in Aug. 81. Avg. value in the three months before recession start: -4.3%

May. 89: True positive. Recession started in Aug. 90. Avg. value in the three months before recession start: -1.7%

Mar. 96: False positive. Recession did not occur. (Only one month when signal was present. Value = -0.77%)

Nov. 98: False positive. Recession did not occur. (Three consecutive months when the signal was present. Values: -0.53%, -0.30%, -0.15%)

Sep. 00: True positive. Recession started in Apr. 01. Avg. value in the three months before recession start: -8.9%

Jul. 06: True positive. Recession started in Jan. 08. Avg. value in the three months before recession start: -5.5% (Warning: in this instance, the six-month change of the LEI-3MA was negative between Jul. 2006 and Feb. 2007, then turned positive for five months, till Jul. 07, and dipped again below zero from Aug. 07 on. In those five months, the six-month percent change of the LEI-MA stayed below 1%.)

Nov. 11: ??? The six-month change of the LEI-3MA was -0.64%, and then it December it was -0.14%. The LEI-3MA does not offer strong-enough evidence, yet, of an upcoming recession.

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