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.