What Is the Index of Leading Indicators?

Economic indicators offer insights into an economy’s health and direction, helping analysts and policymakers understand current performance and anticipate future trends. Among various types of indicators, some are designed to change before the broader economy shifts, providing an early signal of potential economic expansion or contraction. The Index of Leading Indicators stands as a specific composite tool developed to predict these upcoming economic movements. This index helps individuals and businesses make more informed decisions by providing a forward-looking perspective on economic activity.

Defining the Index of Leading Indicators

The Index of Leading Indicators, also known as the Leading Economic Index (LEI), is a composite index specifically designed to forecast future economic activity. This index aims to predict turning points in the business cycle, such as shifts from expansion to recession or vice versa. It is compiled and published monthly by The Conference Board, a non-governmental research organization.

The primary purpose of the LEI is to provide early signals of economic expansion or contraction, typically looking six to nine months ahead. By aggregating diverse economic measures, the index offers a more comprehensive view than any single indicator could provide alone. This composite approach helps to smooth out the volatility that might be present in individual data series, offering a clearer signal of underlying economic trends. The Conference Board carefully selects components based on their logical relationship to the economy and their proven ability to lead economic cycles.

Key Components of the Index

The Index of Leading Indicators comprises ten distinct components, each chosen for its tendency to change before the broader economy. These components collectively offer a multifaceted view of impending economic shifts.

• Average weekly hours worked by manufacturing employees: Businesses adjust hours before workforce changes; an increase suggests growing demand.
• Average weekly initial claims for unemployment insurance: A rise often precedes an employment downturn.
• Manufacturers’ new orders for consumer goods and materials: Reflect future production intentions and consumer demand.
• Institute for Supply Management (ISM) New Orders Index: Signals increasing or decreasing manufactured goods orders, indicating future industrial activity.
• Manufacturers’ new orders for nondefense capital goods, excluding aircraft: Indicate business investment plans for equipment.
• Building permits for new private housing units: A forward-looking indicator for construction, signaling future housing starts.
• S&P 500 Stock Index: Reflects investor sentiment and corporate profitability, often moving ahead of the general economy.
• Leading Credit Index: Assesses credit availability, crucial for business investment and consumer spending.
• Interest rate spread: The difference between the 10-year Treasury bond yield and the federal funds rate, indicating financial market conditions.
• Average consumer expectations for business conditions: Captures consumer confidence, influencing future spending and economic growth.

Interpreting Movements in the Index

Interpreting the Index of Leading Indicators requires focusing on sustained trends rather than single monthly fluctuations. A consistent upward trend in the index signifies anticipated economic expansion. Conversely, a sustained downward trend suggests a likely contraction or slowdown in economic activity. Economists generally look for patterns over several months to confirm a shift in the economic outlook.

A common guideline for interpreting the LEI involves observing the index’s performance over a six-month period. For example, a decline in the LEI by more than 4 percent over six months, coupled with a broad weakening across its components, can signal an impending recession. While three consecutive monthly declines have historically been considered a signal of a turning point, The Conference Board also uses a “3Ds” rule, which considers duration, depth, and diffusion of the decline. This rule helps to differentiate minor fluctuations from significant shifts.

The LEI is a forecasting tool, not a definitive prediction. While it tends to peak and decline prior to recessions, there have been instances where it signaled a downturn that did not materialize. Therefore, the LEI should be considered alongside other economic data and indicators to form a comprehensive view of future economic conditions.