Business Finance
Understanding the Conference Board Leading Economic Index
Written by Bennet Grill for Gaebler Ventures
Economists often argue whether or not the economists is technically in a recession or not; while technical definitions for a recession vary, many economists look to the Leading Economic Index (LEI) as a forecast tool to judge where the economy is heading. Business owners and entrepreneurs can benefit from monitoring the LEI in order to better prepare for financial downturns or upswings.
The data for the Conference Board Leading Economic Index (LEI) was first collected in 1959 in order to gauge the state of the United States economy and predict what future economic activity might hold. The Index is comprised of 10 leading indicators, all of which contribute to the composite score of the index:
1. Average weekly hours, manufacturing
Weekly hours of manufacturing gives an idea of the employment health of the mining and manufacturing sectors; this number is usually positively correlated to GDP growth rates.
2. Average weekly initial claims for unemployment insurance
High unemployment means a slow moving economy and delays the chance for a recovery from a recession
3. Manufacturers' new orders, consumer goods and materials
Manufacturers' new orders reflects the sales of manufacturers and is a sign of consumer demand-- a higher number reflects greater growth
4. Index of supplier deliveries - vendor performance
This number is a signal of the demand for suppliers' products--if delivery times are slow, it indicates that there may be increased demand, which is positively correlated to GDP.
5. Manufacturers' new orders, nondefense capital goods
This numbers seeks to reflect capital expenditures by manufacturing firms excluding purchases driven by defense contracts. This number increasing is a positive sign for American businesses.
6. Building permits, new private housing units
Building permit numbers reflect the status of the housing market, which affects industries ranging from manufacturing to retail
7. Stock prices, 500 common stocks
This variable is derived from the S&P 500, which includes 75% of the equity market in the United States by market capitalization.
8. Money supply, M2
M2 is a measure of money supply that includes M1 (currency held by the population as well as checking accounts) and savings and money market accounts. M2 is a good measure of inflation; if the money supply increases, inflation is soon to follow, holding all else equal.
9. Interest rate spread, 10-year Treasury bonds less federal funds
Simply put, this number is the premium yield of 10 year US Treasuries over the overnight federal funds rate
10. Index of consumer expectations
This value is derived from a survey conducted by the Conference Board which interviews 5000 households about their current concerns and outlook on business conditions and the labor market
One interesting thing to note about the LEI is its consistency in signaling the end of recessions. Since 1959, there have been 7 major recessions; in six of the cases, the month the LEI demonstrates an annualized increase of 12% or more, the recession ends.
Business owners and entrepreneurs can benefit from knowing the likelihood of a change in the economic cycle. If the economy is headed for a recession, business owners would be wise to reduce overhead and cut costs. In the case of a rebound, entrepreneurs would be able to increase their investment and capital expenditure. Hopefully this article has explained each of the ten indicators of the LEI and how they relate to the decisions small business owners and entrepreneurs make.
Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.
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