Lesson 71 – How to Interpret the Index of Leading Economic Indicators

Topic Progress:

In our last lesson we looked at the Consumer Confidence number, an indicator which gauges the mood of the consumer in the US economy. In this lesson we are going to look at an economic indicator which combines many of the leading components of the indicators we have studied thus far into one indicator meant to give insight into where the economy is heading several months ahead of time.

Published around the 21st of each month, the Conference Board’s Index of Leading Economic indicators is made up of 10 sub indices which tend to move ahead of the overall Economy. The 10 sub indices are:

  1. The average weekly hours worked by manufacturing workers – Before hiring or firing employees manufacturing firms will normally increase worker hours when demand requires or cut back on worker hours when demand falters, which is why this is included as a leading economic indicator.
  2. The average number of initial applications for unemployment insurance – As is probably obvious if the number of applications for unemployment increases this means more people out of work, which means people will have less money to spend, which means a weaker economy and market sell offs all else being equal.
  3. The amount of manufacturers’ new orders for consumer goods and materials – An increase in the amount of new orders should indicate a pickup in demand and vice versa.
  4. The speed of delivery of new merchandise to vendors from suppliers – A leading indicator because increase in demand can cause an increase in delivery time as suppliers have trouble keeping up with new demand.
  5. The amount of new orders for capital goods unrelated to defense – another way of looking at new orders which should lead the business cycle as pickups in new orders indicate rising demand.
  6. The amount of new building permits for residential buildings – As builders try to anticipate demand, new building permits normally move higher ahead of demand which is why this is considered at leading economic indicator.
  7. The S&P 500 stock index – As we will learn in our lessons on the stock market, the S&P 500 Index includes the stock prices of the 500 largest companies in the US. And as we have learned in past lessons markets anticipate making changes in the stocks that make up this index a leading indicator of future economic activity.
  8. The inflation-adjusted monetary supply (M2) – in simple terms this is watched as it is a measure of bank lending which increases ahead of economic expansion and decreases ahead of economic contraction making this a leading economic indicator.
  9. The spread between long and short interest rates – as we learned in our lessons on interest rates, normally the shorter term the loan the lower the interest rate one will pay. This is considered a leading economic indicator as when the distance between short term interest rates and long term interest rates narrow this is indicative of a situation where the market participants are anticipating Fed interest rate cuts which
    normally come during economic slowdowns, and vice versa.
  10. Consumer sentiment – This indicator which measures how optimistic the consumer is about the economy is a leading indicator as when the consumer feels that the economy is not good and not going to be good they will normally pull back spending causing economic slowdown and vice versa.

As with all the other indicators we cover, what the market focuses on when this indicator is released depends on what is happening in the market during that time, so the best way to learn how to incorporate this indicator into your analysis and trading is to follow the indicator in real time.