The Long Leading Indicators, Midyear 2014

 |  Includes: DIA, IWM, QQQ, SPY
by: Hale Stewart

By New Deal Democrat

With half of 2014 behind us, we not only have a better idea of how the economy is likely to perform in the second half of this year, but we can also begin to look ahead to the first half of 2015. That's because the long leading indicators usually turn at least 12 months before the economy as a whole does.

At the end of last year, I forecast 2014 to be a year of deceleration, starting stronger and finishing weaker. As we all know, the economy performed a major faceplant in the first quarter instead. To which I plead, pace Dr. Bones McCoy from Star Trek: "I'm an economic forecaster, not a climatologist, dammit!" And further even the BEA acknowledges that it wasn't sure how to account for the beginning of open enrollment under the ACA in its calculations.

Anyway, let's look at each of the long leading indicators in turn. First of all, here are corporate bond yields (inverted):

These turned south in a major way for the second half of last year, and were one of the important reasons why I still believe the second half is likely to feature deceleration from the second quarter. They turned down (up in the graph) in a big way in the first half of this year. This is an important positive for early 2015.

Second, here are housing permits (blue) and real fixed residential investment as a percent of real GDP (red):

Both of these turned largely neutral as 2013 wore on, and are still largely neutral (although Prof. Edward Leamer's important metric, real residential investment as a share of GDP, is down for two quarters in a row through the first quarter of 2014). These again telegraph weakness for the remainder of this year and into next year.

Third, corporate profits turned down slightly in the first quarter after rising smartly in 2013:

These are positive for the remainder of this year, and negative for early 2015.

Fourth, here are Real M1 (blue) and Real M2 (red) money supply:

These have been positive at all times, and are still positive.

Fifth, here are per capita real retail sales:

I added these to my list after noting, from a post of Doug Short's, that these have always peaked a year or more before the onset of all recent recessions. They are basically neutral for the rest of this year, and positive although not strongly so for the first half of 2015.

Finally, many people consider the bond yield spread to be a long leading indicator, although I do not believe it functions that way in ZIRP environments. For example, in 1937-38 the yield curve was positive by over 3% at all times, even though the second worst recession in the last 100 years (after 1929-32) was upon us. The yield curve also never inverted at any point before any of the recessions in the 1940s or 1950. Anyway, for those who follow it, here it is:

In the second half of 2013, interest rates had turned negative, and housing was neutral. Money supply, while positive, was less so than previously. In the first half of 2014, however, interest rates have turned more positive (although they are still higher than their post-Great Recession lows), as has real money supply. The only negative is first-quarter corporate profits.

Thus, according to the long leading indicators, it appears that the economic expansion will continue through the first half of 2015, and may accelerate from another rough patch at about the end of this year.