Mapping the pros: composite economic indicators – mar 2017

In my last post I introduced a heat map of the top individual economic indicators and how the heat maps are a very simple yet useful way at looking at the overall state of the economy. In this post I’ll do the same thing but this time with composite economic indicators.

What is a composite economic indicator and how is it different than an individual indicator? Individual economic indicators typically provide information about one particular aspect of the economy, say housing, and consists of one data series or a composite of related sub-series. A composite economic indicator, as we’re using the term here, tries to provide an overall perspective on the economy and consists of multiple data series each of which provides a different perspective on the economy.

There quite a few private and government entities that put together composite indicators based on the individual economic indicators. Some are quite famous, like the Conference Board, ECRI, and the Chicago Fed National Activity Indicator (CFNAI). These guys are the pros and use sophisticated methods of putting together these composite indicators. We currently track 25 of the composite indicators. Let’s take a look at one example, the Conference Board.

The Conference Board puts together some of the best composite indexes for the US and the World. They have the advantage of a long history, and clearly letting everyone know what individual indices go into their index. They offer a leading, coincident, and lagging indicator. Let’s look at the leading economic index for the US. Below are the components of their LEI.

There are 10 components. The factors are the weighting in the composite index of each component. The factors are calculated to equalize the volatility contribution of each component (similar to volatility weighted asset allocation strategies). They then go through a detailed methodology to calculate the growth rate of the index, trying to identify changes relative to trend. The disadvantage of the Conference Board indexes and many of the other composites is that they can be expensive (or they have delayed free versions) and it’s not the index itself they use to identify recessions. They’ll do some sort of data manipulation (we’ve done that in the heat maps below). In future posts I’ll dive into some of the other composite indicators and show how they are put together. But for now, let’s look at a broad array of these composites and get an idea of what they are saying about the economy.

Just like I did in the last post let’s look at a a historical heat map but this time of the composite indicators. First up, the first 3 recessions starting from 1973. The months highlighted in red are the official start of each recession. We also are developing a composite score, just like with the top 6 indicators, to identify green, yellow, and red states for the overall composite. More to come on that later.

As we saw with the individual indicators, there is a clear deterioration before the start of the recession. Now for the following three recessions.

Same story here. Some deterioration in the composite indicators was worse than others indicating the severity of the recession but the trends were pretty clear. Now for the current state of the composite indicators.

No sign of recession is currently reflected in the composite indicators. There was clearly some weakness in early 2016 but that has mostly gone away. This is the same information we are getting from the top 6 economic indicators and also the broader array of individual economic indicators that we track. And if you look at a broader picture across the world it tells a similar story.

That’s it for an introduction to the heat map of the composite indicators and what they are telling us about the economy today. I’ll update the composite indicators at the beginning of each month. This coming Friday, March 10, is the big daddy of economic reports – the jobs report. I’ll post an update on the SPY-UI indicator then.