Leading Indicators Clash

It's early yet in 2016, but far enough along in January that we’ve all gone through the obligatory gauntlet of New Year predictions and risk calculations. On the whole, it’s a pretty cautious step into another calendar year, and with good reason. For a number of years now, hopes have been high, only to be dashed by a political, meteorological or some other equally unpredictable ‘serial interruption’, right off the bat. So, should we hunker down for another of these first-quarter events, or will structural indicators – that seem to be pointing upward – prevail?

Perplexed by the annoying persistence of what economists would call exogenous (definition: ‘outside-of-the-system’, unpredictable) events, business audiences have asked me whether the models can actually be adjusted to accommodate these regularly-occurring unforeseeable events. The answer? They could, but if a new seasonal pattern of events is emerging – due to climate change or for any other reason – seasonal adjustment would eventually take care of it. So much for technical adjustment; what about that real world we all operate in – what are the data suggesting is on the horizon?

At this point in the year, leading indicators are really helpful. Trouble is, some of the more dependable prescient data points are going the wrong way. Take copper, for example – it earned a PhD in economics for its long-proven ability to foresee economic movements. At the end of 2015, it was down on a year-to-year basis by almost 30 per cent. The last time it ventured there was in 2008, and the time before that, 2001. Hardly encouraging.

Another disturbing indicator is equity market performance. The 5% hit that the S&P 500 took last September was surpassed elsewhere, jolting perceptions of near-term performance, and although there was a rebound, levels are still well below the pre-drop peak. Thus far, the cautionary tone of pundits’ top-of-the year statements seems warranted.

That is, until other leading signals are examined. In the US, average weekly initial unemployment insurance claims are maintaining a steady down-trend, a sure-fire sign of sustainable growth. Moreover, the level is lower than seen in the two most recent troughs in early 2000 and during 2005-07, both periods of excessively low unemployment rates. Building permits, another good US bellwether, continue a solid up-trend. New manufacturing orders for consumer goods and materials are now on an accelerated increase, highlighting strong US consumer demand. Orders for capital goods, which disappointed after a strong rally in 2014, seem back on the up-and-up.

Some will caution that other US Index elements are not as strong. Agreed – the credit index has recently turned down; consumer expectations are not tracking strongly; and the yield curve has flattened somewhat. Here is where a distinction can be made between indicators: there seems to be a large difference between financially-driven signals and those related to a resurgence of real domestic activity. A paradox? In normal circumstances, yes. But given the historic monetary policy tightening underway, led by the Fed, the re-absorption of excessive liquidity is putting the squeeze on equity indexes, commodities, by extension, currencies, and credit availability. These are all elements that would normally head north in a growth cycle. Not this time, thanks to the extraordinary policy measures that have been in effect for years. If we account for this, is there reason, then, for optimism about the near-term future?

Well, put the 10 elements of the Composite Leading Indicator together, and the overall result is an impressive increase that has lifted it to a level just one Index point away from its previous peak in March 2006. At least for the US economy, this critical bellwether stands behind a view that the economy could well outperform early-year predictions, setting us all at a greater level of comfort that will enable us to get on with growth.

The bottom line? The US outlook remains confused by a clash in the views of its forward-looking indicators. Segment those indicators, and it becomes evident that the ones that are not being distorted by policy movements are singularly positive. We believe that this time around, they will carry much more weight.

This has been written by Peter Hall, EDC Vice-President and Chief Economist.