Definition: Leading economic indicators are statistics that precede an economic event. They are very useful in predicting what will happen in the economy. They will be the first data point in a trend, which will then be confirmed by coincident and lagging indicators. The ability to predict a trend is especially important when the economy is reversing - either coming out of a recession or heading into one.
Important Leading Economic Indicators
Durable Goods Orders Report - Don't make the same mistake as most people and ignore this critical indicator. It tells you whether businesses are ordering new big-ticket items such as machinery, equipment and aircraft. Why is this important? The first thing companies do when the economy starts to turn soft is hold off on buying expensive new equipment. They'll just keep the old stuff running for a while to save money. Similarly, the first thing they do when the they think the economy has strengthened enough is buy new equipment. Importantly, don't confuse this report with consumer purchases of durable goods, such as washing machines and new cars. That's an important indicator, as well, but business orders pick up first after a downturn ends.
Interest Rates - This is probably the most important indicator for the average person to follow. That's because falling and low interest rates create a lot of liquidity for businesses and consumers. That means money is cheap, and both are more likely to buy as soon as the economy improves. Similarly, if you see interest rates rise, you know that the economy will slow down in the near future. That's because it costs more to take out a loan, making everyone buy less.
Stock Market - This is a good predictive indicator because investors spend all day, every day, researching the health of businesses and the economy. When stock prices rise, that means they are more confident in future growth. When the major stock indices fall, that means investors are rushing toward traditional safe havens, such as 10-year Treasury notes and gold. Pay particular attention to the Dow Jones Utility Average, which measures the stock performance of utilities. These companies have to borrow a lot to finance their expensive energy generation facilities. Therefore, their earnings are highly dependent upon interest rates. When rates are down, their earnings are up, and so is the utility index.
Manufacturing Jobs - Although overall employment is a coincident indicator, factory jobs are an important leading indicator because they measures manufacturers' confidence. When factory orders start to rise, and they need more workers, it will benefit the other supportive sectors of the labor market. As manufacturers fulfill these orders, it will benefit transportation, retail and administration. Similarly, when manufacturers stop hiring, it means a recession is on its way.
Building Permits - Most cities issue permits for construction of new housing about two to three months after the contract is signed in the new home sale. This is usually around six to nine months before the new home is completed. When permits start to fall, it's an early indication that 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 large component of the economy, as are construction jobs. When this sector is depressed, everyone feels it.
That was the mistake made by economists in the last recession. They thought the housing slump would be contained to real estate. As early as October 2006, building permits for new homes were already down 28% from the year before. This was a very early indication of the subprime housing crisis, which became a global financial crisis by 2008. Housing construction fell as a component of GDP from 6.1% in 2005 to just 2.2% in 2011.
Index of Leading Economic IndicatorsThe U.S. Conference Board publishes an index that measures these and other leading indicators. The Board is a private non-profit that is under contract to the Federal government to publish these and other indices. In my experience, these other indicators aren't as effective in predicting economic trends. I've pointed out the flaws in each. However, the Board's Index should be used in addition to reviewing the leading indicators I've already highlighted. The Index includes:
- Money Supply - This doesn't take into account money invested in stock or bond funds, which also affect liquidity. The money supply is directly affected by the Fed's interest rate moves.
- Consumer Expectations - This is based on a survey of consumers. Even though it asks for their expectations, these are highly skewed by the unemployment rate. This is, itself, a lagging indicator.
- Weekly Claims for Unemployment - Followed eagerly by investors, especially to predict the monthly non-farm payroll report (jobs reports. However, it measures unemployment, which is a lagging indicator, and so doesn't really predict what the economy will do next. Article updated April 25, 2014