Benchmarking the Economy

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 |  Includes: DIA, QQQ, SPY
by: James Picerno

With the last of the June economic data in hand, it's time to update the CS Economic Index, which is calculated monthly. As our chart below shows, and anecdotal evidence suggests, the U.S. economy is weak and getting weaker.

The black line in the chart above, which runs through June 2008, is our broad measure of U.S. economic activity, comprised of 17 variables, ranging from nonfarm payrolls to retail sales to business loans. The index's biggest weighting (a bit more than 40%) is comprised of leading indicators, which are those measures (such as new building permits and disposable personal income) of economic activity that are considered as windows into the future. Another 30% of our broad economic index is made up of coincident indicators with the remaining 30% in lagging indicators. In short, the CS Economic Index is designed to measure broad economic activity, giving a modest bias to leading indicators.

With that in mind, we take no comfort from the relatively sharp decline in the leading component of our index (the red line in the chart above). As you can see from the graph, the leading indicators are signaling that there are more challenges ahead. In fact, the leading indicators have been flashing warning signs for some time now, although the downside momentum has only been bubbling since late last year.

No wonder, then, that the Federal Reserve yesterday decided to keep interest rates unchanged. Fed funds remains at 2%, and for the moment the market expects more of the same. Looking into early next year, Fed funds futures prices are betting on a rise in interest rates, perhaps by 50 basis points. Yes, there are inflation concerns that come with keeping rates below the general level of reported inflation. But for good or ill, the central bank prefers to err in favor of growth. We'll know in the coming months if that bet pays off. For now, we're all invited along for the ride.

As for our economic index's forecast, keep in mind that its insight into the morrow, such as it is, is mostly speculation and therefore subject to change. Ours is an intelligently designed measure of broad U.S. economic activity, or so we believe. And while it factors in so-called leading measures of economic activity into the mix, we have no illusions about the true value of our index: clarifying the past. As for the future, we can only guess. Crunching economic numbers, no matter how you slice it, is first and foremost a venture of looking into the past. Nothing wrong with that; in fact, it's quite valuable for context and so we highly recommend the sport. The key is remembering that it's no substitute for a crystal ball.

At some point the economy will heal, and the rebound will take root. Perhaps the leading indicators will give us an early sign of the approaching bounce, perhaps not. The odds are probably stacked against us for correctly divining the future with any precision as to timing, in part because the full range of economic numbers arrive with a considerable lag. Even if the data was dispensed in real time, that still wouldn't change the fact that economic reports are mostly about the past.

That doesn't stop us from trying to peer into the future, but we do so with the full recognition that our vision is heavily clouded. So it goes when swimming in the murky waters of the dismal science.