A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Economic Indexes Disagree On Odds for a U.S. Recession

So, you can't figure out whether the economy is slipping into a recession or not. Don't worry, you're in good company.

Not only are lots of economists confused about where the economy is headed, but the two indexes often used to predict economic activity currently offer exasperatingly different outlooks.

Wednesday, the Conference Board in New York reported the latest results for its Index of Leading Economic Indicators, which is designed to forecast where the economy is headed in the next three to six months. While the index fell 0.3% in March to 108.5 -- the second consecutive monthly decline -- the board said the pace of the decline wasn't deep enough to prompt an economic contraction. "No recession is on the horizon," the group said. Defining a recession involves many factors, but a common rule of thumb is that it requires two consecutive quarters of decline in gross domestic product, the value of the nation's output.

Meantime, the New York-based Economic Cycle Research Institute says its monthly and weekly leading indexes show a recession is "no longer avoidable." The last time the group made such a call was Feb. 6, 1990 -- just before the economy last plunged into recession.

"I've not encountered a slowdown like this one with so many confusing signals," says Cary Leahey, an economist at Deutsche Banc Alex. Brown in New York. Mr. Leahey says that when predictor indexes are on the mark, they help companies make wise business decisions "and help moderate the extent of the ups and downs in the economy," by helping businesses prepare for slowdowns. But when the indexes are sending mixed signals, economists say, they lose value because businesses have to rely on other planning tools.

There isn't an easy way to determine which index will prove accurate. Neither has a perfect record, and both have flaws. The Conference Board's index missed the previous two recessions, in 1990-91 and 1981-82, prompting some economists to refer to it as the "index of misleading indicators." That may be too harsh, considering the index accurately called recessions in the 10 years prior to 1981. And the Conference Board revised the way it compiles the index in 1995 to eliminate a component that was sending false signals. The ECRI says it correctly called two of the past three recessions.

Economists don't rely solely on either index, though they follow both if only to confirm the trends that they already suspect. Here's what the two indexes are saying about the economy:

Index of Leading Indicators

The Conference Board's Index of Leading Economic Indicators is generally considered the standard, because it uses essentially the same forecasting methods once followed by the federal government, which transferred its leading-indicator program to the Conference Board in 1996. Although the index has declined five times in the past six months -- indicating that the economy is growing at a slower and slower pace -- the group says that's not enough to signal a recession. To forecast a recession, the Conference Board says, the index would have to fall at a 3.5% annual rate during a six-month period, and five or more of the indicator's 10 components would have to be in decline. The old rule of thumb used to be that three consecutive months of decline indicated a strong chance of recession, but in recent years the Conference Board has begun using the more rigorous, six-month standard.

In the past six months, the group's leading-indicator index has fallen at an annual rate of 2.4%. "The latest readings suggest that the economy may be no stronger in the second quarter than it was in the first, and that slower economic growth will continue into the summer," says Ken Goldstein, an economist at the Conference Board. But a recession, he says, isn't likely.

The group said six of the leading index's 10 components worsened in March, including stock prices, vendor performance, weekly claims for unemployment insurance, building permits, interest rates and manufacturers' orders for consumer goods. Components that improved were money supply, consumer expectations and manufacturers' orders for capital goods and materials. Average weekly manufacturing hours held steady for the month of March.

The group's index of coincident indicators, which measures current economic activity, rose 0.1% in March, suggesting that the economy continues to expand, though moderately. The group's index of lagging indicators, which reflects changes that have already occurred in the economy, fell 0.4% in March, the second consecutive monthly decline and the third decline in the last four months.

ECRI Index

More provocative at the moment are the indexes fashioned by Economic Cycle Research Institute, a private research group dedicated to studying business cycles. Some economists contend that the ECRI performs a more complex analysis than the Conference Board because it creates multiple indexes for different parts of the economy, rather than one broad leading index.

The group computes 11 leading indexes, including those for the manufacturing, construction, finance and services industries. It also includes a "Long Leading Index" that forecasts broad trends in the economy in the coming year, a "Short Leading Index" that forecasts six-month broad trends, and indexes for inflation, credit, trade and employment. The group doesn't compute a composite score that includes all the indexes, and it doesn't have regularly scheduled releases of all the indexes.

Unlike the Conference Board, the ECRI has no hard-and-fast rule for determining when the economy is definitely headed for recession. Instead, it uses internal formulas to compare recent indexes to previous business cycles, determining how pronounced, pervasive and persistent the current problems appear to be. When the negative trends appear to be so bad that a recession can't be avoided, the group makes a call.

Lakshman Achuthan, managing director of ECRI, notes that all but one of the group's leading indexes are now pointing toward recession (the exception is the group's "Leading Services Index," which forecasts activity in the service sector, though he expects it to decline as consumer confidence falls). As a result, the group says, "the economy has passed the point of no return, beyond which it is not possible to shift away from the recession track."