03/09/16   The Leading Economic Indicator

Editor’s Corner

Ron Rowland
Is the economy getting better, worse, or holding steady? That question remains unanswered for many people, but if you have a strong view, then you can probably find the data to support it. Action in the stock market is said to discount future events, which is a fancy way of saying that stock prices are typically a leading indicator instead of reflecting past economic status.

In fact, stock prices are a key ingredient in one of the most widely followed economic forecasting indexes. The Conference Board Leading Economic Index (“LEI”) is based on ten variables believed to be correlated with future economic activity. Historically, the LEI turns down before a recession and up before an expansion. Like all indicators, its track record is not perfect, and it has been chided for predicting recessions that never materialized. Still, the index contains insightful information, is widely used, and is well-respected.

The S&P 500 Index is one of the LEI’s ten components. Each component is weighted (or adjusted) by its volatility so as to equalize the volatility of each component’s contribution. The last LEI report, published in mid-February and based on January data, showed a decline in the Index. The primary reason for the decline? It was the relatively large 5% drop in the S&P 500 Index.

Four of the ten components declined in January. Increasing initial unemployment claims, the ISM new orders index, and building permits were the three variables joining stock prices to take the overall indicator lower. Manufacturers’ new orders for consumer goods held steady, while the remaining five posted improvements. They were the interest rate spread, capital equipment expenditures, average weekly manufacturing hours, an improvement in the Leading Credit Index, and consumer expectations about business conditions.

This was the second month in a row that the LEI declined. However, The Conference Board tells us there is no need for concern at this time because the six-month change is still positive, and the strengths and weaknesses appear to be nearly balanced. The report containing February’s data is due to be released next week (March 17).

Investor Heat Map:3/9/16

Sectors

Two more sectors transitioned into positive intermediate-term trends this week, putting nine of the 11 sectors in the green. Financials and Health Care are the odd men out, although they both have the potential to remedy that situation in a matter of days. The big winner this week was Energy, in terms of both relative and absolute strength improvements. In the relative strength rankings, Energy jumped from last place to seventh. From an absolute strength perspective, the 34-point jump in its momentum score was more than two times larger than the 16-point gain of Financials, which posted the second-best gain. However, in the case of Financials, its big momentum boost was not enough to move it out of its next-to-last-place position.

Telecom and Utilities continue to lead the pack, and the duo has now shared the top-two spots for seven consecutive weeks. Materials has been aggressively climbing the rankings for five weeks and this week mounted a three-place improvement to take over the third-place spot. Its move did not affect the positions of Industrials and Real Estate, but Consumer Staples ended up falling three spots to sixth. Energy and Technology were the two sectors flipping from red to green this week, although Technology slipped a spot in the rankings instead of zooming higher like Energy.

Styles

Last week’s hollow victory of six style categories moving to green looks more solid today. However, the big news is the dramatic shift in the overall rankings, and I will get to that in a minute. The reason for the previous hollowness was that none of the six were able to post a momentum score any higher than two last week, and three of them were barely on the plus side of zero. Today, the quantity of upwardly trending styles increased to nine, and they are all posting respectable momentum scores.

Today’s big shift is significant for many reasons. First is the unseating of Mega-Cap from the #1 position it held for 23 weeks. It didn’t just slide down a notch or two but plunged all the way to seventh. Second is the across-the-board jump in Value categories at the expense of the Growth categories. Lastly, the huge jump in the absolute strength of Micro-Cap and Small-Cap Value suggests there are more changes to come. The top-ranked spots are now held by Mid-Cap Value, climbing from fifth, and Small-Cap Value, jumping from eighth to second. Large-Cap Value moved three places higher, putting all three Value categories in the top four, while none were there a week ago. I already mentioned the six-place drop of Mega-Cap, but Large-Cap Growth “beat” that with a seven-position plunge (second place to ninth). Before you run out and sell your Mega-Cap and Large-Cap Growth funds, please be aware that both posted improved momentum scores this week. These categories are not declining. It’s just that they are having trouble keeping up with the pace being set by the other categories.

Global

Latin America completed its six-week climb from last place to first place. Sometimes, first place is not all it’s cracked up to be. On a longer-term perspective, Latin America remains the worst-performing global category. The rankings are based on intermediate-term momentum, and they in turn are fueled by short-term performance, which has been spectacular. So, we have a case of Latin America being short-term overbought while remaining long-term lousy. The translation is that there is some question about the sustainability of its intermediate-term ranking, but the upside potential is huge. Canada held the top spot for the past four weeks and eased down into second today. Pacific ex-Japan and Emerging Markets flipped from red to green and moved higher. The improvements noted above came at the expense of the U.S. and World Equity, both slipping lower in relative strength despite moving from the red to green side of the ledger. Only five global categories now remain in negative trends, and their negative readings are all mild enough to be easily overcome in the days and weeks ahead.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“The U.S. LEI fell slightly in January, driven primarily by large declines in stock prices
and further weakness in initial claims for unemployment insurance.”

-Ataman Ozyildirim, Director of Business Cycles
and Growth Research at The Conference Board


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