Leading Economic Indicators and How to Use Them

Are We Headed Into Another Recession? Check These Indicators First.

Boeing 737 construction is a leading economic indicator.
Manufacturers' orders of durable goods, such as aircraft, is an important leading indicator. Photo: Photo: Jeff Hunter/Getty Images

Leading economic indicators are statistics that precede economic events. They predict the next phase of the business cycle. That becomes especially critical when the economy is either coming out of a recession or heading into one.

Leading, Lagging, and Coincident Indicators

The other two types of indicators are coincident and lagging indicators.

Coincident indicators occur during the trend. The number of employees added or subtracted each month is the most influential coincident indicator. The Employment Situation Summary is released by the Bureau of Labor Statistics.

Note

There are three types of economic indicators: leading, coincident, and lagging.

Lagging indicators occur after the trend. They either confirm or refute the trend predicted by leading indicators. For example, the unemployment rate typically rises after a recession has ended. There's a good reason for that. Even when growth improves, employers are hesitant to hire full-time workers again. They wait to see whether they can count on the growth continuing.

Top Five Leading Indicators

There are five leading indicators that are the most useful to follow. They are the yield curve, durable goods orders, the stock market, manufacturing orders, and building permits.

The Yield Curve

The Treasury yield curve is the most important indicator for the average person. It predicted all of the last eight recessions: 1970, 1973, 1980, 1990, 2001, and 2008. The yield curve also inverted before the 2020 recession.

The yield curve shows the return on short-term Treasury bills compared to long-term Treasury notes and bonds. In a normal yield curve, returns on short-term notes will be lower than the longer-term bonds. Investors need a higher yield to invest their money for longer.

When the yield curve inverts, it often foreshadows a recession, but the timing of the ensuing pullback is highly unpredictable. Incidentally, an inversion occurs when short-term Treasury bills and notes offer a higher yield than longer-dated Treasury bonds. If investors are willing to accept a lower return for the long-term bonds, then you know they are very uncertain about the near future.

Note

Go to the U.S. Department of the Treasury's Daily Treasury Yield Curve Rates.

The yield curve also tells you whether interest rates are rising or falling. Low interest rates make loans cheaper. It allows businesses to expand, and families to buy cars, homes, and education. When interest rates rise, you know the economy will slow down soon. It costs more to take out a loan, making everyone buy less.

The yield curve is not perfect. It inverted in 1966, although no recession occurred afterward.

Durable Goods Orders

The durable goods orders report tells you when companies order new big-ticket items. Examples are machinery, automobiles, and commercial jets. This isn't the same as consumer purchases of durable goods, such as washing machines and new cars. That's important, but business orders change before the business cycle changes.

Note

Go to the U.S. Census Bureau's latest Durable Goods Orders Report.

For example, when the economy weakens, companies delay purchases of expensive new equipment. They'll just keep the old machines running to save money.

The first thing firms do when they regain confidence in the future is to buy new equipment. They need to replace the old machinery and gear up for higher anticipated demand.

Orders for durable goods declined in January 2008. A few months later, the Bureau of Economic Analysis declared the 2008 recession. Durable goods orders began falling in October 2018, months before the 2020 recession.

Note

The most well-known stock indices are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq.

Stock Market

The stock market is a good predictive indicator. A company's stock price represents the firm's expected earnings.

Investors spend all day, every day, researching the health of businesses and the economy. A rise in stock prices means they are more confident about future growth. A fall in the stock market means investors are rushing toward traditional safe-havens. They'll sell stocks and buy 10-year Treasury notes or gold.

The Dow Jones Industrial Average crashed on March 9, 2020, accurately forecasting the 2020 recession.

However, both the stock market decline and the ensuing recession were directly related to anxiety, uncertainty, and economic disruption associated with the COVID-19 outbreak.

Pay particular attention to the Dow Jones Utility Average. It measures the stock performance of 15 big utilities. These companies borrow a lot to pay for energy generation facilities. As a result, their profits depend on interest rates. When rates are low, their earnings are up, and so is the utility index.

Manufacturing Jobs

The number of manufacturing jobs tells you manufacturers' confidence level. Although overall employment is a coincident indicator, factory jobs are an important leading indicator.

Note

Compare how many manufacturing jobs were added this month with the Bureau of Labor Statistics' Jobs Report.

When factory orders rise, companies need more workers. That benefits other industries like transportation, retail, and administration. When manufacturers stop hiring, it means a recession is on its way.

Building Permits

Building permits tell you what will happen with new home construction nine months from now. Most cities issue the permit two to three months after the buyer signs the new home sale contract. That's six to nine months before builders complete the new home.

Note

The U.S. Census publishes the number of building permits issued each month. Download the excel spreadsheet title "Permits by State - Monthly." Make sure to use the tab marked "Units SA" for the seasonally adjusted rate.

When permits start to fall, it's a clue that the demand for new housing is also down. When that happens, it usually also means something is wrong with the resale market. Real estate is a significant component of the economy, as are construction jobs. When this sector weakens, everyone feels it.

For example, economists made that mistake in the 2008 recession. They thought the subprime mortgage crisis would be contained within real estate. As early as October 2006, building permits for new homes were down 28% from October 2005. It was an early indicator of the housing crisis and the 2008 global financial crisis.

Index of Leading Economic Indicators

The U.S. Conference Board publishes a Leading Index that is, itself, a good indicator of what's going to happen in the economy. If you can only look at one indicator, this would give you a quick snapshot. Since it is a composite, it won't give as full a picture as the five indicators outlined above.

The Index measures 10 leading economic indicators. Five of them are listed above. These are combined with the five indicators summarized below. These indicators aren't as useful as the top five at predicting economic trends. The reasons are outlined below:

  • Weekly Claims for Unemployment: Investors use this report to predict the monthly jobs reports, but it measures the unemployment rate. That's usually a lagging indicator. Employers avoid laying off workers unless they absolutely have to. They also don't rehire until they are absolutely sure the economy is getting better. The unemployment rate often rises long after the recession is over.
  • ISM Index of New Orders: This surveys more than 400 purchasing executives in the manufacturing sector. If the new orders report is above 50, manufacturing and the economy are growing. It is a very useful indicator, but if you are short on time, the Durable Goods Orders Report will reveal a similar outlook.
  • Leading Credit Spread: It measures six financial indicators, such as margin account balances, bank credit, and security repurchases. It is a good forward indicator if you understand the underlying financial products and their potential impact on the credit industry. The Treasury yield curve has similar predictive capacity.
  • Consumer Expectations: This is based on a survey of consumers. It asks for their future expectations. It tells you whether consumers think business conditions, jobs, and incomes will improve in six months. Most respondents base their future predictions on how well they are doing now. For example, many people are still unemployed even after a recession is over.

How to Use Leading Indicators

Leading indicators are the first data point in a new phase of the business cycle. They occur during the old cycle but give a preview of what's about to happen. Here's how to use each of the top five indicators.

Yield Curve: Keep an eye on the yield curve monthly. It can invert years before a recession actually occurs. For that reason, monitor it but don't take action until other leading indicators confirm the yield curve's trend.

Durable Goods Orders: Review the durable goods order report monthly. It will vary significantly month to month. A large portion of it is commercial aircraft, mostly Boeing, and its orders swing wildly. Also, look at the portion of the report called "Capital Orders Without Defense and Transportation." It eliminates the unevenness of commercial and defense aircraft orders.

Stock Market: The stock market also has a lot of daily variabilities. Most of it is noise, but it's important to note if the market falls more than 20%. That's a bear market, and it usually accompanies a recession.

Manufacturing Jobs: Manufacturing jobs are released monthly in the Jobs Report. If it steadily declines month after month, you know a recession is likely.

Building Permits: The building permits report is also released monthly. A quick review will tell you how developers feel about the future of housing.

Frequently Asked Questions (FAQs)

What should I do if economic indicators point to a recession?

There are things you can do to prepare for a recession, and many of them are measures you can take that will improve your finances, no matter how the economy is doing. These things include paying down debt, focusing investments and retirement accounts on long-term growth, and finding places to cut back on your spending.

How long do recessions last?

While recessions can last from several months to several years, the average length of recessions that have taken place since 1945 is 11 months.

When does a recession become a depression?

There are some key ways to tell the difference between a recession and a depression. While recessions are measured in quarters, depressions are measured in years. Technically, the U.S. has had only one depression, which was the Great Depression, which lasted 10 years. Since that time, there have been measures put in place by the U.S. government to stop another depression from happening.

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Sources
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  1. Bernard Baumol. "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends, Third Edition," Page 198. Pearson Education, 2013.

  2. Bernard Baumol. "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends, Third Edition," Page 349. Pearson Education, 2013.

  3. Federal Reserve Bank of St. Louis. "The Yield Curve Versus the Unemployment Rate in Predicting Recessions."

  4. U.S. Department of the Treasury. “Daily Treasury Yield Curve Rates.”

  5. Bernard Baumol. "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends, Third Edition," Page 148. Pearson Education, 2013.

  6. Federal Reserve Bank of St. Louis. "Manufacturers' New Orders: Durable Goods."

  7. WT Wealth Management. "List of Major Leading and Lagging Economic Indicators."

  8. S&P Dow Jones Indices. “DJIA Daily Performance History, “ Download DJIA Daily Performance History.

  9. S&P Dow Jones Indices. "Dow Jones Utility Average," Download "Methodology" PDF. Page 3.

  10. The Conference Board. "The Conference Board Leading Economic Index."

  11. Bernard Baumol. "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends, Third Edition," Page 204. Pearson Education, 2013.

  12. U.S. Census. "Building Permits Survey," Download excel spreadsheet "Permits by State - Monthly." Use tab marked "Units SA."

  13. U.S. Department of Labor. “Unemployment Insurance Weekly Claims,” News Release June 18, 2020.

  14. Institute for Supply Management. “May 2020 Manufacturing ISM Report on Business.”

  15. Moody's Analytics. "United States - ISM: Purchasing Manager's Index."

  16. Bernard Baumol. "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends, Third Edition," Page 184. Pearson Education, 2013.

  17. The Conference Board. "Description of Components," Go to "Leading Credit Index."

  18. The Conference Board. “Consumer Confidence Survey.”

  19. National Bureau of Economic Research. "Business Cycle Dating."

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