If you casually listen to business news, you may have heard that the U.S. economy is arguably on the brink of a recession because inflation still hasn’t been tamed, the yield curve is inverted, and consumer confidence is low. However, in the same newscast, you probably learned that the S&P index is up more than 10% for the year, unemployment is low, and retail sales are still growing.
It’s common for the economy to be giving mixed signals. It’s also unsurprising that making predictions about the future is about as accurate as “dart-throwing chimps.” So where are financial analysts and economists getting their information? A series of data points, known as the Leading Economic Indicators, are the most widely cited statistics that provide us with insight into where our economy is headed.
The Conference Board, a nonprofit research organization, publishes its Leading Economic Index® (LEI) for the United States, which includes 10 different data sources: three financial components in the Leading Credit Index, S&P 500 Index, and the interest rate spread (10-year Treasury bonds less the federal funds rate) plus seven non-financial components, including average consumer expectations for business conditions, ISM® Index of New Orders, building permits for new private housing units, average weekly hours in manufacturing, manufacturers’ new orders for nondefense capital goods, excluding aircraft orders, manufacturers’ new orders for consumer goods and materials, and average weekly initial claims for unemployment insurance. Changes in these numbers often suggest future economic conditions.
The primary reason this index is considered so accurate is that each component measures different areas of economic activity. Roughly 70% of our economy comes from consumption expenditures, meaning essentially, if Americans are employed, they will spend their money. Should unemployment claims increase, the short-term demand for consumer goods is likely to slow. However, consumers’ attitudes toward future conditions also foreshadow when spending may wane. When demand for capital goods, such as buildings, machinery, and tools, slows, it indicates long-term production is declining, which also may be reflected in fewer manufacturing hours. The spread in interest rates shows when the relative cost of borrowing money increases, a sign of financial stress, which can affect the demand for housing and companies’ long-term plans for growth. As growth slows, so can stock prices. Finally, when companies start to feel the pinch, often we see layoffs.
While each component can affect another, the LEI is not a perfect system. Indicators can dip for several months and then accelerate without a recession. Furthermore, the time between a turning point in one metric and the change in another can be 12 to 24 months. As we all know, a lot can happen in two years—say, the coming and going of a pandemic, the beginning and end of a war, or the discovery and integration of a disruptive technology.
Investors should use the LEI for a better idea of the economy’s direction—not as a tool to time stock prices. These indicators can help you with tactical moves, such as positioning your portfolio in a defensive stance or being overweight in growth for an expanding economy. Your overall portfolio strategy should stay constant in all economic conditions, including having your spending needs covered with bonds to match timing and amounts needed.
If you have questions on how the changes in the economy affect your portfolio, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the October 21, 2023 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
