Leading Economic Index Decline Adds to Recessionary Red Flags

  • The Conference Board’s Leading Economic Index showed another decline for October, suggesting the economy will finish the year on a low note.
  • The LEI isn’t the only worrying trend pointing to an eventual recession.
  • Even as the economy slows, the stock market could continue to climb in the near-term. But long-term worries persist.

On Thursday, the Conference Board revealed that its Leading Economic Index for the US declined to 111.7 in October. This is the third consecutive monthly decline for the LEI, and its six-month growth rate was negative for the first time since May 2016. The figures suggest the US economy is slowing; the Conference Board’s Ataman Ozyildirim says that by the end of the year, economic growth will have fallen below 2%. 

Recession on the Horizon?

This isn’t the first time economic data has started to wobble. Recession indicators and market crash warnings have been in the headlines for months now, and traders are becoming increasingly worried about the potential of a stock market crash. 

The Conference Board is a leading indicator, meaning it tends to signal economic movements before they occur. It’s certainly a well-respected indicator, but it would be irresponsible to rely on the LEI alone. That’s because although it’s based on a wide range of data dating back to the 1950’s, that range simply isn’t wide enough to create a reliable sample size. The data that the Conference Board uses has been through just 11 recessions. On top of that, much of the data was collected before the internet was even an idea— a good chunk is from a time when a wagon was considered a form of transportation. 

Bond yields are trending lower, a worrying sign of falling confidence in the US economy. | Source: CNBC

Still, the LEI is telling and it’s not alone in predicting a slowdown. Bond yields dipped this week as well on worries about crumbling trade negotiations between the US and China. Dropping yields suggest that investors are expecting rate cuts, another potential sign that a recession is on the horizon. 

Another worrisome trend that suggests slowing economic growth is a drop in manufacturing capacity utilization. When manufacturers are using more of their production capacity, it indicates that demand is strong; low utilization implies the opposite. Capacity utilization among manufacturers has trended downward for the majority of 2019, another tick in the potential recession box.

The housing market offers another peek into the future of the US economy, but again the picture isn’t rosy. Housing starts saw a 9.5% decline in September and residential investment has declined over the past six quarters.

Recession Isn’t Imminent, but the Possibility Is Growing

It’s impossible to predict the exact timing of a recession. In fact, markets typically aren’t aware or a recession until after the fact. But warnings that a slowdown is on the horizon are becoming louder. Janet Yellen, the Fed’s former Chair noted that although the economy is in “excellent” shape now, it’s facing some serious headwinds. She pointed to wealth inequality and the US-China trade war as potential threats to economic growth. 

I would bet that there would not be a recession in the coming year. But I would have to say that the odds of a recession are higher than normal and at a level that frankly I am not comfortable with.

Jeffrey D. Korzenik, Managing Director and Chief Investment Strategist at Fifth Third Bank says he believes the economy has “shifted into a lower gear” as US businesses struggle with labor shortages. 

Our view at Fifth Third is that the U.S. economy has necessarily shifted into a lower gear.  In particular, the labor shortage is constraining our ability to grow rapidly and businesses are adjusting to this new reality by lowering their hiring plans.  Traditionally, businesses would be compensating by higher levels of capital investment to make their existing labor force more productive, but that is not happening; the decline in business confidence that started with trade tensions is now being weighed upon by uncertainty in U.S. politics, so that capital investment remains low.

What It Means for the Stock Market

stock market, recession
Markets closed lower over the past three sessions as traders digested the lackluster figures. | Source: Yahoo Finance

With an economic slowdown looking like a best-case scenario, investors could become understandably jittery. Stocks closed lower for the third consecutive session on Thursday, but that doesn’t mean the bottom is going to fall out in the near-term, says Korzenik. 

He expects the market to broadly continue gains but noted that long-term challenges remain. 

‘Slow but sustainable,’ the formula that drove most of the early years of this bull market, suggests that the stock market will broadly continue gains. The longer term challenge is that the path to continued sustainability of growth has narrowed since we have run out of labor market slack and productivity gains will be limited without capital investment.

The Bottom Line

Investors should be prepared for more lackluster data to close out the year. While that doesn’t mean a recession is on the doorstep,continuing weakness in the labor market as well as trade headwinds are starting to chip away at economic growth. If these problems continue to stack up, a recession wouldn’t be out of the question. With that in mind, investors shouldn’t panic sell. Most experts agree that diversified portfolios and adequate savings are the best way to ride out the storm. 

Disclaimer: The above should not be considered trading advice from CCN.

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