Leading Economic Index Confirms the Recession Is Over

 |  Includes: DIA, SPY
by: Elliott Gue

I like to look at year-over-year change in LEI (Leading Economic Index) as a quick and excellent take on the health of the US economy. All too often I hear pundits on financial television and in various media offer ad hoc analysis of every economic data point released during the trading week, twisting these indicators to fit their own preconceived notions.

I firmly believe that the consistent application of a handful of time-honored economic indicators--such as the 10 that compose LEI--is infinitely preferable.

As I’ve written before, my reading of LEI suggests the US recession ended over the summer and the economy is now enjoying a cyclical recovery. I suspect that factors such as excessive consumer debt and banana republic-style spending by the federal government will ultimately make this recovery less robust than any previous recovery over the past two decades.

Nevertheless, over the next few quarters it’s likely growth will be strong, and I suspect it might even surprise the consensus to the upside; this fact alone suggest more upside for the S&P 500 into 2010.

It certainly hasn’t paid to fight the tape this year. The S&P 500 has already enjoyed a considerable advance since the March low.

Here’s a look at the year-over-year change in LEI back to the late 1960s.

Source: Bloomberg

The LEI jumped 0.6 percent in August, slightly less than the 0.7 percent that the consensus had expected heading into the report. But the Conference Board also revised the prior month’s report higher from 0.6 percent to 0.9 percent; taken together the picture was actually more positive than expectations.

This marks the fifth straight monthly gain in LEI, one of the most impressive run-ups in the indicator in decades. On a year-over-year basis the LEI is up 1.9 percent, well into positive territory.

Even if we do see some modest downside revisions to the data in coming months--always a possibility with this indicator--it’s unlikely the year-over-year change would be below 0 due to these changes. I’ve highlighted the 0.0 line on the chart above, and you can clearly see that the LEI is behaving much as it has at the end of each recession covered by the chart.

As always, it’s worth digging into the data in more depth to look at the constituent indicators. Once again this month, the indicator of vendor performance surged and was a big upside push for the LEI.

Source: Bloomberg

This chart shows the speed at which companies are receiving deliveries from their suppliers; the higher the index, the slower the deliveries.

If you’re a company producing a product and it takes longer for you to get supplies, it likely means your suppliers are struggling to meet demand and are experiencing delays. They may even be running up backlogs of unfilled orders as they attempt to find ways to boost production.

Another big contributor this month was a jump in consumer expectations. We’re seeing further evidence of a modest improvement in consumer spending and confidence in the form of some positive recent retail sales reports.

Another interesting data point: Carnival Cruise Lines (NYSE:CCL) noted that bookings have jumped 19 percent year-over-year, an indication that some leisure travelers are spending again, albeit only on when discounts are offered to lure buyers.

By far the greatest drag on LEI this month was a decline in the US money supply.

Source: Bloomberg

Early this year I noted that huge growth in the money supply caused the LEI to be far stronger than it otherwise would be. I also stated that in order for their to be a true recovery for the US economy I would need to see improvement in the index due to more than growth in money and attractive interest rate spreads, the components of LEI most directly controlled by the government.

The fact that money supply fell this month but the LEI still jumped is proof that the recovery isn’t solely based on monetary stimulus.

The huge growth in money supply over the past few years is a huge long-term threat to the US economy. But that’s a worry for the next five years, not the next six to 12 months.

Last week I received some positive feedback via e-mail about my article on railcar loadings as an economic indicator. This indicator, unlike LEI, doesn’t involve data released by the US federal government.

One reader commented that container ship loadings at major ports might be another interesting statistic to examine. Here’s the data for the massive Port of Long Beach in California.

Source: Port of Long Beach

Statistics on container traffic are usually quoted in terms of the total volume of 20-foot equivalent units (TEU) handled. Basically, these are standardized containers measuring 20 feet in length, eight feet in height and eight feet in width. Standardizing the size of containers makes it easier to move them from ships to trains and trucks on their journey from producers to consumers.

I’ve added granularity to the data, breaking it down into both loaded inbound and outbound cargos; the former is good representation of import volume, while the latter shows exports traffic.

The graph clearly shows a sharp slowdown in volumes after October 2008. Total containers moved fell an unprecedented 43 percent from that inflection point through February 2009; this tumble is easily distinguishable from the seasonal rises and falls in traffic.

However, since February volumes have risen sharply once again, reaching 380,000 TEUs in August, the highest level since last October. In most years traffic remains elevated through December before slowing down in the New Year. If that pattern continues containership traffic easily could surge to over 400,000 TEUs in coming months.