Looking Ahead: Leading Indicators Give Us Hope

This week promises little by the way of new data on the economy, instead most eyes will be on Ben Bernanke as he gives his regular testimony before Congress. The key issue we will all be focusing on in his comments is his strategy for unwinding the extraordinary monetary policy of the past few months before it turns malevolent by pumping up inflation.

Other than that we only have today’s leading indicators from the Conference Board, retail sales for June on Thursday and the weekly claims for unemployment insurance. A light week indeed.

Well what about those leading indicators?

Sad to say not much.

The message being delivered by the index is very much a confirmation of what we already know: the economy is slowly turning the corner from free-fall to tentative recovery. For instance, the index has now risen for three straight months. That rules out any aberration: there is a clear trend emerging – as you can see from the graph in the press release I linked through to. Over the past six months the index has risen about 2%, which is a sharp contrast with the previous six months when it fell 3.1%. So the turn around is now significant enough for us to rely on as a true indication of the economy’s performance.

The leading indicators index is a composite. The idea is to take a view of several data sources and then combine them into one statistic. As its name suggests the index is compiled from various data sources that have been shown in the past to change course, either up or down, ahead of the economy as a whole.

The problem – and as usual there are problems – comes from the components of the index that are not improving. There are three very important data sources: real money supply, manufacturers orders of capital goods, and consumer expectations that are not improving. And these three carry a lot of weight in our analysis of the shape and speed of recovery.

Just to illustrate my point:

One of the positives in the index is the length of the manufacturing work week. All the signs are that manufacturers are very slightly operating more hours as they start to replenish depleted inventories. This is a sure sign that the much anticipated fall re-stocking is a reality. Consequently we can expect a lift to GDP from increased inventories – perhaps sufficient to bring the decline of the economy to an end. But all the signs are that such a turn of events will have an empty feel to it. The recession will have ended on a technical basis, since GDP will no longer be contracting, but that isn’t exactly what we want: we need GDP growth in order to re-generate jobs and to keep up with population growth.

Put it another way: GDP may start to grow in total, but it may still be declining per capita.

One of the reasons we should be wary of the potential speed of the recovery is within today’s index. Consumer sentiment remains in the tank. I hate to sound like a broken record, but consumer spending is still the lifeblood of the economy. As long as consumers remain cautious the economy may grow, but it will not grow quickly.

And an economy that doesn’t grow quickly will not create many jobs. Nor will it provide wage increases.

Surveys of businesses show that they may not be shedding jobs as quickly as they were in the winter, but they are certainly not re-hiring either. In fact the emphasis remains on cost cutting, with downward pressure on wages increasing. So while the leading indicators include a positive report of longer work hours, other reports, not included in the index, show a much more pessimistic view of working conditions.

So the long awaited recovery has all the early signs of a ‘jobless’ recovery. In which case we are heading into a prolonged and turbulent period. The economic outcome I most dread is where GDP meanders at a slow and steady rate of growth, but not sufficiently to spur job creation. The past eight years were an example of what happens in such an episode: wages stagnate because there is no labor shortage, profits bulge because productivity expands but employers are not forced to ‘share the wealth’, and income inequality inexorably creeps up. Ultimately that kind of economy ends up in social turmoil: the social contract of the 1950’s and 1960’s was built on very different premisses: strong wage growth, moderate profits, and the entrenchment of the New Deal. For the record: those two decades saw the fastest accumulation of national wealth in American history. We should be very wary of extending the mistakes of the Reagan/Bush era much longer.

Meanwhile: the leading indicators give us mild cause for hope that we will end this recession soon. It’s what happens beyond then that we should all be thinking very hard about.