The top 6 indicators on the state of the economy

A quick post on a new page I have added to the blog. In the top menu you will see a page called ‘Top 6 Economic Indicators“. On this page you will find FRED graphs of 6 economic indicators, updated automatically when new data is available. I’ll tell you a bit more about these indicators below and why they were chosen.

First, there are a lot of economic indicators these days. There are individual indicators (we track 66 of them), like the unemployment rate, for very measuring very specific aspects of the economy, and composite indicators (made up of many individual indicators), like the Conference Board Leading Index, which are meant to get a general direction of the economy. The terminology can be a bit confusing. The indicators are classified into either leading, co-incident, or lagging indicators. Leading what? Good question. The relative positioning is referenced to business cycle peaks, not recessions as many people think. But we’re interested in recessions/economic disruptions and more importantly their effect on markets. That’s why you’ll see use of co-indident and even sometimes lagging indicators as recession predictors.

We have chosen 6 out of 66 individual indicators that have the best track record of identifying recessions and are useful in making market decisions based on our analysis of the historical data. There are 4 leading indicators and 2 co-incident indicators. The 4 leading indicators are the unemployment rate vs its 12 month moving average (this is the single best indicator), the yield curve – difference between the 10yr UST and the 3 month T-Bill, Leverage in the economy, and private housing permits. The 2 co-incident indicators are year over year change in industrial production of durable consumer goods and year over year change in real retail and food sales.

Great. Now what? Well, now you can put these indicators into a composite index and see how a trigger of these indicators matches up with actual recessions and peaks in the stock market. Below is a graph of a Composite indicator going back to 1973 that triggers (goes to 1) when 3 or more of the 6 are signaling a potential upcoming recession. The recession boundaries are shaded in light blue, and the dark blue line is the drawdown of the SP500.

A few key items I’ll point out about the chart. Recessions are usually bad for stocks. No surprise here, that’s why we’re doing this. But the market can also go down quite a bit without a recession (1987 being the best example). The COMP indicator does a pretty good job of triggering before the recessions and the steep market drops. But it’s not perfect by any means. There will be false positives, with respect to recesions, with any indicator. Some false positives are bad, like the early 2006 trigger, some are not, like the 1987 trigger before the sharp drop. We’ll have a lot more to say about the COMP and other indicators and its use in market timing in subsequent posts.

OK. That’s a quick background on the top 6 economic indicators that we’ll track here going forward. And in closing I’ll say that none of the 6 are triggered right now.

 

Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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6 Responses to The top 6 indicators on the state of the economy

  1. Tony says:

    Hi Paul,

    Thanks as always for posting such great info.

    I know there has been criticism for awhile about how accurate the unemployment rate is, and I am sure there are similar criticisms for some of these other indicators you mention. I have not put too much stock into these criticisms, but with our current president I am getting a bit more concerned. Curious what you think about this: https://www.bloomberg.com/politics/articles/2017-02-20/trump-team-fosters-fears-he-ll-adopt-alternative-economic-facts

    Thanks,
    Tony

    • paul.novell@gmail.com says:

      Hey Tony, I don’t think much about stuff like that. It’s all politics like most of the criticisms of gov’t data.
      That could change of course but I doubt it.

      Paul

  2. Damian says:

    Paul, appreciate the information here and in your other posts on economic indicators. (I would have added this to your most recent post, but I can’t find a comment link.)

    Simple, but fundamental, question here: this is extremely interesting, but do these more complex means of economic tracking offer meaningful benefits to investors besides just using the SPY-UI indicator, or something else comparably simple, to improve risk-adjusted returns?

    I’d have to think they do, knowing your general preference for simplicity, but I understood from the series of posts relating to the SPY-UI indicator that it pretty much had been demonstrated to be the easiest and most effective way over time of avoiding deep drawdowns.

    I’d imagine there are ways to try to be more precise and get out closer to tops, but at the cost of whipsaws.

    • paul.novell@gmail.com says:

      Hey Damian,

      Great question. My answer right now is I don’t know. The SPY-UI system remains king in my book and it is what I am using in my investment portfolio. But the SPY-UI system has some big holes that I’m looking to improve. Right now, a composite indicator based on my top 6 indicators does about the same as the SPY-UI system going back to 1973. I do find the heat maps add important context though. For example, the UI signal triggered last year, but the SPY-UI did not. This made many people quite nervous. The heat maps were providing no confirming signals. In subsequent months the UER was revised and the UI trigger went away. So, at worst I figure all this stuff is important for context, confirmation, and maybe most important emotional management.

      Paul

      • Damian says:

        Belated, but well-deserved, thanks here — appreciate this and all your fine work. This might be obvious, but I’ll say it explicitly — I never would have ventured into economic indicators if not for your investigation and presentation that you’re doing in these posts. I likely would have been yet another “it’s all manipulated anyway” types, and I know all too well that you lose money and/or opportunity with that mindset.

        • paul.novell@gmail.com says:

          Happy to hear Damian. And congrats on making the transition. Most can’t.

          Paul

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