Conference Board Indicators and their Use

The Conference Board was founded more than 90 years ago in order to guide businesses toward better performance by providing research and information on a wide range of economical issues. It is a non-profit organization, and as such, holds tax exempt status in the United States.

In this text we’ll examine the three types of indicators released by the Board on a monthly basis. These indicators are divided into the three groups of leading, lagging, and coincident indicators based on the correspondence between their release data and the type of data covered by them. In addition to classifying the data released by the Board, the division is utilized by many other foundations and institutions in order to classify information.

Leading Indicators: Leading indicators provide information about the future direction of economic events. They are derived from the analysis of data with long-term impact, and they thus provide some insight to the future of economic developments. Of course, leading indicators only speak about probabilities. They are useful, but do not provide certain guidance about the future (if they did, trading would be so much simpler, after all).

There are many kinds of leading indicators that most people deal without even being aware of it. A very good example is the lending surveys conducted by the many central banks of the world. Since the amount of credit available in an economy has a direct bearing on the future of economic activity, and also because the impact is felt slowly over a long time, it is possible to predict the future growth performance of any economy on the basis of the lending policies of its banks. If, for example, banks contract credit for a significant period of time, it is usually clear that economic activity will shrink, and GDP will fall or stagnate. As such, bank lending statistics act as a kind of leading indicator for overall economic activity.

Another, even more obvious and stronger example would be the Federal Funds Rate. Since the Federal Funds Rate is the cost of the cheapest borrowing available in the economy, it has a powerful impact on the willingness of firms and consumers to borrow. Since borrowing usually leads to more investment and more spending, a better average GDP growth rate is the expected outcome over the longer term. As such, the Fed Rate can be regarded as another kind of leading indicator for overall economic activity.

By contrast, lagging indicators describe conditions that are anterior to the release data. A good example is the GDP report: it takes a long time to prepare the GDP report, and past GDP growth usually has little relationship to the future of economic activity in a nation. As such, the GDP report only provides a snapshot of economic situation as it existed in the past. The unemployment rate is another example: unemployment rates begin to fall a while after the economy has stabilized, and as such, they provide little value in terms of predicting the future. On the other hand, they can provide clues about the future of consumption, and can also be regarded as a leading indicator in that respect.

The third type of indicators are coincident indicators. These are usually timely snapshots of economic activity at the time they are released, and give important clues about the status of the economy as it stands, but do not provide a lot of insight into future developments. An example of this type of information is the retail sales data. This type of data usually reflects the perceptions of consumers about the present state of their finances, but does not say much about future economic activity.

Leading, coincident, lagging indicators are released by various U.S. departments regularly, and traders react to them depending on the amount of surprise generated. Thus, although for example the current production data in the GDP release may not be as important as data contained in the banking survey, the market may choose to give a very muted reaction to the latter in the short term, if the GDP numbers surprise to a greater degree.

Now let’s a take a deeper look at the Leading Indicators released by the Conference Board to study the details of the report.

Leading Indicators

The conference Boards’ leading indicators are a group of data published by the foundation on a monthly basis in order to predict the future performance of the economy in the months ahead. The individual indicators are then combined to create a composite of Leading Indicators, which is the headline number focused on and reacted to the by the markets. The components making up the composite of leading indicators are 10 in number, and here we’ll examine each one of them on an individual basis, and explain the rationale that causes them to be regarded as leading indicators.

1. the average weekly hours worked by manufacturing workers: The manufacturing sector is very sensitive to recessions, since retailers order goods and products based on their anticipation of future consumer demand. In turn employers adjust the weekly hours in order to suit the amount of demand potential which they expect to be generated by the economy in the medium term. The Conference Board uses this information as a important component of the leading indicators.

2. the average number of initial applications for unemployment insurance: This number takes the previous month’s weekly jobless claims data, averages it, and generates a value which is then compared with the data of the previous month. Since the non-farm payrolls release is a lagging indicator (especially for recoveries) the composition of the leading indcators chooses to focus on the high frequency data which is known to anticipate recoveries. At normal times this number would remain around 300,000, and any rise above that level is thought to signal that difficult times are ahead for the economy.

3. the amount of manufacturers’ new orders for consumer goods and materials: The services sector generates much of the activity in the U.S. economy, but much of that activity is dependent on some kind of manufactured good. For instance, a web developer may be providing an intangible service to his customers, but before he can begin his task, he needs to obtain some computers and other necessary equipment. Similarly, in order to have fashion designers employed, people need to buy clothes, which means new business for manufacturers. The best gauge of the robustness of manufacturer’s business is generally thought to be the new orders number released in the ISM’s PMI, and this number is also borrowed from there to be included in the leading indicators release.

4. the speed of delivery of new merchandise to vendors from suppliers: This piece of data, taken from the ISM’s PMIs, is a good indicator on the future price pressures that could eventually be manifested in the CPI numbers. If suppliers are delivering goods without much delay, the implication is that there is no tightness in the market, and prices do not need to rise very fast, implying tame inflation. On the other hand, slow supplier deliveries implies capacity constraints, which can only be managed by rising prices, or rising capacity. Needless to say, future price pressures and inflation have important implications for the Federal Reserve’s interest rate policies, and, of course, for GDP growth in general.

5. the amount of new orders for capital goods unrelated to defense: Capital Goods are large items, like important factory and office equipments, which businesses need to ensure higher yield, and better productivity in the long term. Capital goods expenditures are important indicators of future economic activity for two important reasons. First, they reflect the sentiment of the industrial sector, since managers will only invest in capital goods if they feel that there is enough demand and competition in their sector. If the existing level of production is enough to satisfy consumer demand, they’d better focus on cost cutting, than capital expenditures. In addition, capital goods expenditures directly influence future productivity, and future production. Thus, the capital expenditures of businesses is an important forward-looking item among the leading indicators.

6. the amount of new building permits for residential buildings: Although the housing sector is a smallish part of the overall U.S. economy, a home is one of the most important sources of wealth and investment for a typical household, and as such, the dynamism of the sector has wider implications for the health and confidence of the U.S. consumer. In addition, the establishment of a new household usually accompanies the creation of a family, birth of children, all of which entail additional economic activity. Besides, the new building permits data is the most ‘leading” of the numerous indicators on the health of the housing sector. It is therefore included among the leading indicators of the Conference Board.

7. the S&P 500 stock index: In the modern age of internet and information technology, many families, workers, and laborers have their life savings invested in the stock market. A rising stock market will lead consumers to feel safer, richer, which then leads to higher spending and higher economic growth. In addition, the stock market is generally regarded as a powerful risk indicator by many powerful actors in the financial world: if the stock market is rising, they will invest more, and speculate more, creating employment, liquidity, and a generally healthier environment for entrepreneurship, and investment. The S&P 500, comprising of some of the biggest and most powerful corporations in the U.S. and the world at large, is an excellent indicator for the health of the U.S. financial sector, and is therefore included in the leading indicators list.

8. the inflation-adjusted monetary supply (M2): The growth of the money supply is a good indicator on the amount of money changing hands in the economy. A higher amount of credit implies a higher amount of borrowing, and higher borrowing means greater investment, more numerous, and productive employees, and higher GDP growth.

9. the spread between long and short interest rates: One of the more important pieces of information included among leading indicators, this data simply states the gap between long and short term interest rates, and by extension, measures the long term profitability of banks and financial corporations. The financial sector bases its profitability expectations on this gap as well, since the sector makes a large section of its profits by borrowing at a low price in the short term market, and lending to businesses and consumers at a higher cost with a longer term. The gap has been shown to be a very reliable indicator of future recessions, and it is included in the composition of the leading indicators data.

10. consumer sentiment: Almost every trader knows the importance of the consumer for the health and dynamism of the U.S. economy. If consumers feel confident about the future, they will borrow more, spend more, leading firms to hire more labor, which will all cause higher GDP growth. On the other hand, if consumers feel frightful about the future, and choose to save up to prepare for difficulties, economic activity will slow down, businesses will be less willing to spend for capital expenditures, leading to falling inflation, and lower potential growth. All these give consumer sentiment an important role as a gauge of future economic activity.

Using the Leading Indicators

In general, the leading indicators release has limited significance for short-term trading. Markets are often unpredictable in the short-term. They might react strongly to any release if it is surprising enough, however, the leading indicators release is usually too abstract to generate an immediate strong reaction in the market. On the other hand, for long-term traders, especially fundamental analysts, the leading indicators can be a very useful and fruitful tool.

The composite of leading indicators is known to lead GDP growth by about six-months or so. By using this indicator in combination with other analytical tools, we can have a good forward-looking analysis of present economic conditions. It is always a better idea to supplement the information available in the release with other data, such as the LIBOR, or conditions in the financial markets, but the leading indicators are a popular and powerful tool for anticipating future activity.

Lagging Indicators

The lagging indicators are released by the Conference Board each month providing insight on financial developments in the past few months. As we discussed above, the economic impact of lagging indicators are felt by economic on a delayed basis. If a lagging indicator is rising, it is confirming a development which has already taken place in the past. Bank lending for example, is a leading indicator for recessions (that is, it precedes the commencement of a recession), but is a lagging indicator for recoveries (in other words, the indicators reflect the improvement after the recovery has begun, and is already being observed by market participants and analysts. Due to their delayed nature, lagging indicatos are used to confirm economic events, rather than predicting them.

There are seven lagging indicators which are used to construct the Composite of Lagging Indicators released by the conference Board to the public.

1. Average Duration of Unemployment. this indicator measures the average of weeks an unemployed worker remains out of work during the past month. In other words, it is a way of measuring how tight or difficult the labor market is. If unemployed workers have to spend a lot of time looking for jobs, the implication is that businesses are unwilling to recommence hiring, and thus lack confidence in the future of the economy. This value is inverted to present a lower value in a recession, and a higher value in an expansion. Recovery in the labor market (or deterioration), is subsequent to recovery or deterioration in the general economic environment. As such this item is included as one of the lagging indicators.

2. Inventories to sales ratio. The stocking and liquidation of inventories reflects the expectations of managers. Inventories are lagging indicators in recessions (managers usually liquidate inventories a while after they are aware of deteriorating conditions in the economy, and falling consumer demand), and recoveries (managers beguin to replensih stock vigorously only after they are confident that the economy is firmly on the path to recovery. The inventory to sales ratio tends to rise into the middle of a recessions, then declining to low levels, and once again rising during recoveries as managers begin to restock. The Conference Board obtains the inventory-to-sales ratio from the GDP data released by the BEA (Bureau of Economic Analysis).

3. Average Prime Rate: The prime rate is simply the interest rate charged by banks to their mostly highly-rated customers with good credit scores and past performance. Banks adjust the prime rate immediately after the Federal Reserve declares its own changes to the funds rate. The prime rate is reflective of the Fed Funds Rate, which can be a leading or a lagging indicator depending on the competence of the governors leading the institution. In cases where the Boar of Governors fails to anticipate falling inflation, the rates will come down only in response to an actual recession. Conversely, if the bank cannot anticipate a recovery, the rates will begin to rise only after inflation has risen materially.

The Conference Board makes the assumption that central banks cannot anticipate economic events efficiently, and considers the prime rate a lagging indicator.

4. Commercial and Industrial Loans Outstanding: Banks adjust their lending policies in response to economic developments. Thus, at the beginning of a recovery, the lending policies of banks will remain restrictive, and only after there are credible signs that the economy is on a firm route to recovery will they begin to expand credit liberally. Since commercial and industrial loans command higher interest rates in general, are more sizable, and often riskier, the adjustments in the category tend to lag economic recoveries by a year or more. If the cause of a recession is non-financial, banks begin to contract credit a while after the economy begins to contract. Thus the commercial and industrial loans category is usually a lagging indicator of recoveries and recessions.

5. Change in Labor Cost per unit of manufacturing output: This item peaks during recessions, as output usually shrinks much faster than labor compensation even in an open and capitalistic economy like the U.S. The data is gathered from various manufacturing industry resources, as well as BEA and the Federal Reserve.

6. Ratio of Consumer Installment Credit to Personal Income: The behavior of the consumer is often more erratic in comparison to the actors covered by other lagging indicators. However, it is generally true that consumers are overoptimistic heading into recessions, and too pessimistic while leaving them. As a result, consumers head into recessions which too much borrowing, and in the phase leading to the recovery they end up borrowing too little. Of course, it is possible that consumers borrow in and out of recession if they have no other way of sourcing their ordinary expenditures. Nonetheless, this credit/income ratio has confirmative value as a lagging indicator of economic activity. The consumer credit data is obtained from the Federal Reserve.

7. Consumer Price Index: Inflation falls while heading into a recession, and in rare cases it may even be negative, signifying depression. Conversely, while recovering from a recession, inflation tends to rise slowly, as consumers spend more and firms acquire greater pricing power. In both cases, inflation tends to lag economic cycles, because both consumer demand, and corporate confidence tends to gather strength only after the economy itself gains some momentum.

Using the Lagging Indicators

The lagging indicators are used to confirm economic developments. While leading indicators emit signs about what might happen in the future (that is, whether we’ll be in a recession, or a recovery a few months from now), and once a trader or analyst has made up his mind about such a scenario, he will use the lagging indicators to confirm his outlook. It is possible to use technical tools and methods (such as seeking divergences between the leading.and lagging indicators) for evaluating the data better. But in all cases the seven components of this release, and their composite, is used as a confirmatory tool for changes in the direction of economic trends.

Coincident Indicators

The coincident indicators are created to present a snapshot of economic activity at about the time they are released. As such, they are helpful for understanding where we are in the business and credit cycles, and which part of a recession or recovery the economy is going through. Unlike leading indicators, they are not thought to predict anything about future activity. And in contrast to lagging indicators, they do not tell much about the past.

1. Non-Farm Payrolls: The non-farm payrolls data is not predictive of future changes in unemployment, income, or consumption, but it is useful for creating a portrait of the U.S. economy as it exists at the time of the release. Unemployment and job openings at U.S. firms are extremely important components of the equation determining GDP growth, which is essential to ensuring better living standards and income levels for all U.S. residents. Traders use the unemployment numbers for many purposes, from determining the interest rate policies of the Fed, to anticipating the beginning of recessions.

2. Personal Income, Less Transfer Payments: This item measures the personal income of U.S. residents, excluding social security payments, and income transfers overseas (such as the transfers of migrant workers to their home countries). It is useful for establishing the income trends in the economy which in turn are reflected in consumption statistics, and thence in production and GDP. Income statistics are always carefully watched and eagerly anticipated by market participants both due to the large role of the consumer in the economy, and because of the implications for GDP. Present personal income will have implications for future consumption, but it is also an important component of the present picture, and is thus included among coincident indicators.

3. Index of Industrial Production: This item records the production of mines, factories, utilities, and similar industrial facilities in the U.S. It corresponds to the Federal Reserve’s own series on industrial production, and captures a snapshot of the manufacturing sector. The data is gathered from firms and factories around the United States on a regular basis, and then combined to create the index.

4. Manufacturing and Trade Sales: This index measures the changes in the sales of manufacturing firms and trade flows.

Using the Coincident Indicators

The coincident indicators are useful taking a snapshot of economic activity in the recent period, and comparing it with the past data (as presented by the lagging indicators) in order to see where we are heading.

Conclusion

The best way of using the leading, lagging, and coincident indicators is combining them to create a continuous picture of industrial activity in the United States during the course of approximately a year, half of it in the future. Although the Board’s indicators show a reasonably close correlation with economic activity in the past, the observed correlation is mostly a result of hindsight. The close relationship observed today is the result of improved and revised statistics and numbers which were not available to traders and analysts at the time the leading indicators were first released.

Still, the data is valuable, and has some predictive value for anticipating recessions and recoveries. The Conference Board’s tools are a valuable addition to the analysts arsenal, and when they function well, they can lead to the very profitable trading decisions.

Chris Lee

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