Excellent thoughts here from the always rational David Rosenberg:
The Conference Board’s index of 10 leading economic indicators (LEI) rose 1.2 points in May to an eight-month high of 100.2, and this was on top of a one point gain in April. In the 50-year history of the data series, two-plus point advances in the LEI over a two month interval has never occurred in the context of a recessionary backdrop — usually either in an expansion or at the very tail end of the downturn. Let’s keep in mind that while the headline was impressive, both months had a diffusion index of 70% — more often than not, when we do see recessions end the diffusion index is usually somewhere between 85% and 100%.
Over the last two months, nearly 60% of the improvement in the LEI came from financial variables — the stock market, real money supply, the yield curve. Another 40% came from two inputs that are taken from survey data — consumer expectations and the ISM vendor delivery subindex.
But what is really interesting is that the actual economic variables have not contributed one iota to this two-month very exciting bulge in the leading index. In fact, if you did a composite of the five economic components — building permits, hours worked, real core capital goods orders, real consumer goods orders, and jobless claims, they collectively were -0.05% last month. Go figure.
So what we have is an LEI that is being fuelled by a stock market rebound from egregious oversold lows (which may now be over now), a narrowing in credit spreads from Armageddon levels, and survey data/diffusion indices. It is tough to believe that the recession is indeed over at a time when hours worked, which feeds directly into GDP, is still making new lows.
When recessions do end, what’s normal is for the financial and survey segments of the LEI to be joined by the hard economic components in the ‘plus’ column. In fact, as we saw in November 2001 at the trough, usually the sum of the contribution from the economic segments comes to 40bps, not -5bps as was the case today.
Not only that, but it would help the cause of the growth bulls if the index of coincident indicators was to make a bottom, but alas, it fell 0.2% MoM in May. Of course, this is far off the much larger negative readings earlier this year when the U.S. economy was in freefall, but back in 2001 the worst number we ever saw (excluding 9/11) was -0.2% and the range in the early 1990s downturn was -0.1% to -0.4%, so to say that the recession has somehow come to a close when the coincident indicator is declining 0.2% seems a little off base. As for what it will take to no longer take the LEI with a grain of salt, we have to see the diffusion index of strength do a lot better than 70% and we have to see the economic components do much better.