What Is the Composite Index of Leading Indicators?
The Composite Index of Leading Indicators, otherwise known as the Leading Economic Index (LEI), is an index published monthly by The Conference Board. It is used to predict the direction of global economic movements in future months. The index is composed of 10 economic components whose changes tend to precede changes in the overall economy. Businesses and investors can use the index to help plan their activities around the expected performance of the economy and protect themselves from economic downturns.
- The Composite Index of Leading Indicators is another name for the U.S. Conference Board Leading Economic Index (LEI)
- Its is geared toward predicting the direction of the overall economy over the next few quarters.
- The Index consists of 10 components that indicate the short-term future course of various sectors of the economy, combined into a composite indicator of general economic performance.
Understanding Composite Index of Leading Indicators
LEI is intended to give an overall indication of the near-term future performance of the U.S. economy. It includes key economic data points that are logically connected to the economic conditions that influence things like consumer spending and business investment. For example, one component of the LEI measures new applications for unemployment benefits, which is thought to indicate increases or decreases in unemployment. Changes in unemployment in turn suggest changes in future consumer and business spending.
By combining data from multiple different sources into a composite index, the LEI can give a more comprehensive signal to help predict overall economic performance, as opposed to a single indicator. Items are included in the index based on their logical relationship to the economy, their properties as leading indicators, and their ease of interpretation. The 10 components of the LEI are:
- Average weekly hours worked by manufacturing workers indicates consumer income and business demand for labor to engage in ongoing production.
- Average number of initial applications for unemployment insurance indicates possible changes in unemployment, which reflects the level of business activity and affects consumer income.
- The volume of manufacturers' new orders for consumer goods and materials indicates businesses' short-term operational spending.
- The new orders index from the Institute for Supply Management's Purchasing Managers Index (PMI) indicates whether orders for various manufactured goods are increasing or decreasing.
- The volume of new orders for capital goods (except aircraft), unrelated to defense, indicates business plans for longer-term future production involving durable capital.
- The number of new building permits for residential buildings indicates future spending on construction projects.
- The S&P 500 stock index indicates the total value of the business sector and the nominal wealth of stock holders in the economy.
- The inflation-adjusted monetary supply (M2) indicates the purchasing power of highly liquid assets available in the financial system for business and consumer borrowing and spending.
- The spread between long and short interest rates indicates bond market participants' expectations for future performance of the economy.
- Average consumer expectations for business conditions indicate forward-looking consumer sentiment for the next six to 12 months.
The Composite Index of Leading Indicators is a number used by many economic participants to predict what will happen with the economy in the near future. By analyzing the index in relation to the business cycle and general economic conditions, investors and businesses develop expectations for the future economic environment and can make better-informed decisions.
According to data from The Conference Board, the LEI tends to peak approximately 11 to 12 months ahead of a recession. The index attracted headlines in January 2023 because its latest peak had occurred in February 2022, with consecutive monthly declines for the remainder of the year raising red flags about an impending recession. In December 2022, which marked the tenth month of the LEI's downtrend, seven of the 10 index components fell.
The recent performance of the LEI paints a bleak picture about the near-term future of economic growth, suggesting that a recession could hit the U.S. economy in the coming months. Although there have been signs of inflation slowing, the Federal Reserve remains committed to fighting inflation. Additional interest rate hikes and a continuation of restrictive monetary policy could add downward pressure on the economy and exacerbate the challenges highlighted by the LEI.
Is It Possible to Predict a Recession?
Economists and market observers rely on a variety of indicators to gauge the economy and anticipate its future developments. The Leading Economic Index (LEI) published by The Conference Board is one tool to take the pulse of the overall U.S. economy and forecast potential downturns. However, making accurate predictions about recessions is difficult. A 2018 working paper by the International Monetary Fund showed that economists are often unsuccessful at forecasting the onset and magnitude of economic downturns.
How Can I Prepare Myself Financially for a Recession?
Recessions are difficult periods. With the increases in unemployment that occur during an economic downturn, job security can be a serious concern. Part of preparing for a recession might be shoring up your emergency fund. This way, if you do lose your job, you can cover your expenses for a few months without dipping into your savings or investments.
How Can I Protect My Investment Portfolio in a Recession?
Economic downturns are stressful for those worried about their investment portfolios. It is important for investors to keep things in perspective, remembering that the tough economic times won't last forever. If you own a diversified portfolio, you may benefit from simply holding onto your investments until the economy recovers. If you decide to readjust your investments, you can look for defensive stocks with a greater potential to withstand the recession. You can also take advantage of dollar-cost averaging during a market downturn, buying assets at lower prices and lowering your average cost.
The Bottom Line
The Composite Index of Leading Indicators, or Leading Economic Index, is published monthly by the Conference Board. The index combines 10 components designed to forecast the upcoming performance of the U.S. economy. The index posted steady declines throughout 2022, raising concerns that a recession could hit the economy in the early months of 2023.