We use leading indicators at ITR Economics to discern future business cycle movements. Our leading indicator analysis is distinct from our economic forecasting, but does inform our forecasts and support our 94.7% forecast accuracy rate.
Leading indicator analysis is based on actual economic data and can provide a business with a look around the corner as to where the business cycle is heading, where your markets are trending, or most importantly what economic pressures your business will experience.
We often find that two sets of economic or company data are highly correlated, but that the peaks and troughs in one series tend to occur before the peaks and troughs in the other. When this relationship is consistent over time, we can calculate the lead time, or the amount of time that tends to occur between each set of peaks and troughs. By shifting the timing relationship accordingly, the peaks and troughs of both series will align more closely, and the leading indicator’s data will extend into the “future” of the other series. Assuming that the underlying relationship between the two sets of data has not changed, the path of the leading indicator can suggest the future directionality and even magnitude of business cycle movements.
For example, the ITR Leading Indicator™ is a proprietary index of ITR Economics which is comprised of consumer, industrial, financial, and global components. Changes in the ITR Leading Indicator TM suggest the possible course of movements in the US industrial economy approximately three quarters in advance. Decline in the ITR Leading Indicator since a January 2018 peak suggests that industrial activity will enter a slowing growth trend in the third quarter of this year. Similarly, our proprietary ITR Consumer Activity Leading Indicator TM is declining, which suggests slowing growth in consumer spending during the second half of 2018.
Some of our other favorite leading indicators include the US Purchasing Managers Index (PMI), which tends to lead the industrial economy by 9-15 months. The PMI 1/12 rate of change has generally declined since mid-2017, which also suggests that the US Industrial Production will enter a slowing growth trend in the last quarter of 2018. We also track the US Total Industry Capacity Utilization Rate, which measures how much existing production capacity is in use across the manufacturing, mining, and utilities sectors. The decline in this leading indicator suggests that US Industrial Production will tip over into the backside of the business cycle in the near term.
We utilize a variety of additional sector-specific leading indicators when analyzing company or industry data. No one single leading indicator can guarantee the direction of the business cycle. However, a comprehensive analysis can give a “peek around the corner” as to where the economy or your company is heading, allowing you to make proactive business decisions and stay ahead of the competition. Use of a system of leading indicators will allow you to plan for what is ahead, and thus give you the means to position yourself for a profitable future, all while your competitors are unsure as to what is happening next.
Lauren Saidel-Baker, CFA
Economist