When Tea Leaves Won’t Do: Parsing Leading Indicators for Clues to Economic Turning Points

When the financial world is seeking clues about the future, it may turn to any of several leading economic indicators. Leading indicators are valued for their predictive qualities, as opposed to coincident and lagging indicators, which have more to say about the present or the recent past.

During a recession, leading indicators can provide clues about how long the downturn might last and how deep it may go. When a recovery begins, it might first appear as a flicker in one of these key reports, which reveal the behaviors of businesses and consumers that can foretell changes in the business cycle.

Big 10

Probably the easiest way to track the main leading indicators is to watch The Conference Board’s Leading Economic Index, which tracks interest-rate spread, average weekly initial claims for unemployment insurance, average weekly manufacturing hours, index of supplier deliveries, stock prices, manufacturers’ new orders for nondefense capital goods, index of consumer expectations, real money supply, building permits, and manufacturers’ new orders for consumer goods and materials.¹

Notice that many of these variables track behaviors that are the genesis for broader economic activity. For example, when orders for supplies, materials, and capital equipment increase, it usually means that manufacturing employees will be busy in the ensuing months. The fact that manufacturers are willing to risk the expense of buying the ingredients to make finished goods indicates they are confident that consumer demand will be enough to provide a return on their investments.

Skivvies, Stallions, and Skin Care

Economists also like to track some fairly unusual leading indicators, some of which may be more valuable for entertainment than as a basis for financial decisions.

Sales of men’s underwear: Former Federal Reserve chairman Alan Greenspan reasoned that when men feel pinched by a tightening economy, underwear is one of the first purchases they postpone because few people see a man’s underpants. Therefore, a dip in sales could give clues about the depth of a downturn; an increase could indicate rising confidence.

Thoroughbred sales: Keeneland is the world’s preeminent horse auctioneer. Due to the highly speculative nature of race horses, prices fetched at the auctions in Lexington, Kentucky, can provide insight into the attitudes of the wealthy.

Cardboard and scrap metal sales: Scrap metal is a significant source of raw material for industrial production. An estimated 75% to 80% of nondurable goods is shipped in cardboard packaging.² Therefore, an uptick in sales of either can be an early signal of economic growth.

Cosmetic sales: When people are feeling uncertain about the economy, they may postpone expensive indulgences and reward their own frugality with less-expensive luxuries, such as lipstick. Cosmetic sales jumped 25% during the Great Depression, and lipstick sales increased by 11% in autumn 2001.³

Economic indicators can be a good source of clues about trends, but it takes experience and skill to interpret their meaning. Any decision based on such clues should also take into account your long-term financial strategy.

1) The Conference Board, 2009
2) Investopedia, 2009
3) The Economist, January 22, 2009

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.