If you were perusing this space last month, then you’d read a bit about lagging indicators. You now understand some of the more popular metrics we use to gauge where the economy has been, you know, in the past. You’re pretty much an expert on that now.
But do you know the future? No, not yet?
After you make it through the rest of this column you will be a super hero. Your super power will be limited to a very narrow subset of economic metrics that will prepare you to sound like an economics professor at a cocktail party. I’ll give you a tip I use myself in these instances: don’t hang around one couple too long and you’ll still sound smart.
Oh, I already know the future: you are going to make it halfway through this column, get bored, have a sip of coffee, answer an email, hit the head for a bio break and forget what you were doing. Before you know it, it’s going to be time for a meal and we will have ended our reader/writer relationship.
But thank you for making it as far as you did, it’s been an enjoyable ride.
You’ve likely heard about this one, but you may not totally get it yet. Let’s dig in.
The yield curve helps us to see, in pictorial form, the difference in yield between shorter and longer term Treasury bonds.
A bond is a contract provided by a corporation or governmental entity guaranteeing that as long as the issuing entity remains solvent it will pay the lender, an investor, a specified interest rate for the money lent.
It is reasonable for an investor to expect a higher interest rate for longer lending periods because as the bond maturity date stretches further and further into the future, the possibility of default, among other risks, increases. It stands to reason, then, that for shorter holding periods investors wouldn’t require as high of a rate as the longer periods.
When a yield curve inverts, meaning when Treasury bills with shorter terms to maturity yield higher rates than the longer term bonds do, it is widely seen as predictive of a coming recession. If an investor is willing to accept a lower yield for a longer holding period, it may be indicative of a broader sentiment of concern about the economic future.
While no leading indicator is fool-proof, a yield curve inversion has preceded each of the last seven recessions, and the curve is currently inverted.
Then there must be a recession coming, right? Not so fast.
While the inverted yield curve might tell us what happens next, it doesn’t tell us when. That’s the hard part, and it’s where my superpowers grow weak.
Durable goods orders
This one is a bit deeper in the economic weeds, but still mainstream enough that CNBC will regularly reference it.
Durable goods orders track increases and decreases in consumers’ and businesses’ orders for new big-ticket items. Consumer durable goods include furniture, washing machines, and cars, while business durable goods include trucks, boats or planes. These items aren’t expected to quickly wear out, and should yield benefits for the purchaser over longer periods of time.
When these orders increase it leads to ongoing or increased manufacturing activity which ultimately fuels the economy.
A decrease in durable goods orders could lead to an increase in inventories and a decline in production.
A larger than expected monthly increase can be considered inflationary, causing bond prices to drop and interest rates to rise.
Housing starts and building permits
These are exactly what they sound like, metrics that track new residential construction (housing starts) and permitting for new construction (building permits).
Because of real estate’s significance in our economy, it accounts for nearly 17% of domestic GDP with housing representing 27% of domestic investment and comprising 5% of GDP, it can serve as a relatively reliable guide to our economy’s future health.
Prolonged shifts or trends in this indicator signal eventual impacts on labor, construction, raw materials, banking, and real estate. Market watchers value this data as a leading indicator as do manufacturers (in planning production), property developers, insurers (in adjusting their rates), and banks (in allocating capital).
When starts and permits decrease, it signifies shrinking demand and can portend a less robust economic future.
As the Federal Reserve raises rates, it increases the cost of mortgages and is expected to reduce demand for housing, thus putting downward pressure on this metric and the economy.
Conference board leading economic index
For those of you who think that following all of these indicators is just too much work to handle, you will find this index particularly useful.
The Conference Board Leading Economic Index tracks 10 economic indicators, some lagging and some leading, to give us a sense of where the economy is headed.
Among the indicators it follows are average weekly manufacturing hours, average weekly unemployment claims, leading credit index, consumer confidence and stock prices.
That’s right, stock prices are factored into this index because the stock market is widely viewed as a leading economic indicator.
If a company’s stock price is based on investors’ estimation of that company’s future profitability and earnings estimates, then the strength of the stock market might reasonably predict the future health of the economy.
Some notable naysayers have pointed to 1987’s stock market crash and the ensuing fervency of economic growth to discredit the predictive nature of stock market pricing, but it is still widely used as an economic indicator.
You deserve a high five
You know, we’ve been through a lot together.
We’ve laughed, we’ve cried, we’ve learned about how to predict the future in semi-reliable ways, you’ve taken a well-deserved bathroom break and probably eaten a snack to keep up your strength while powering through the boring parts of this column.
I’m giving you a virtual high five now. I couldn’t have done this without you.
If we ever get to meet in person, I owe you a drink. We make one hell of a team.
Anthony M. Conte is managing partner at Conte Wealth Advisors based in Camp Hill. He can be reached at [email protected].
Registered Representative Securities offered through Cambridge Investment Research Inc., a broker/dealer, member FINRA/SIPC. Investment Advisor Representative Cambridge Investment Research Advisors Inc., a Registered Investment Advisor. Cambridge and Conte Wealth Advisors LLC are not affiliated.