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Forecasting Fog

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Submitted by Atlas Indicators Investment Advisors on August 27th, 2024

Economic indicators give a sense of an economy’s present state.  But even coincident indicators offer only a model of reality.  Enter forward-looking indicators.  These are measures which have historically given a glimpse into things to come. If you think quantifying the current state of an economy is difficult, predicting its future is much more so.

 

Historically some leading indicators have usually been consistent about turns in the business cycle.  For instance, an inverted yield curve, such as measured by the yield difference between the two-year and 10-year treasury debt, has been reliable harbinger of economic downturns.  This phenomenon, where short-term debt instruments yield more than long-term ones, suggests investors' lack of confidence in the near-term economy.  As you can see above, this indicator has been signaling a downturn for over two years but one has yet to develop.  Similarly, the Leading Economic Index (LEI) from the Conference Board, designed to forecast future economic activity, has (until its most recent release) shown signs that typically precede a recession.  The ISM Manufacturing Index, another bellwether, indicated contraction in the manufacturing sector earlier this year, even reaching lows recently which often signal broader economic troubles ahead, though none have materialized.

 

Employment indicators have also suggested difficulties ahead recently.  A significant drop in temporary employment often foreshadows a decline in overall employment (since March 2022, it has shed 467,200 jobs; a 14.7 percent drop).  Further, the Sahm Rule, which triggers when the three-month moving average of the unemployment rate rises by 0.5 percentage points or more relative to its low during the previous 12 months, has also been activated, traditionally indicating a recession is underway.

 

Some might even point back to the first half of 2022 when the American economy experienced a two-quarter decline in output.  While this has historically been a prescient rule of thumb, no such drop occurred.  Ultimately, a recession is dated by the National Bureau of Economic Research.  Something is keeping this economy afloat; it could be fiscal spending or excess savings held over from the various stimulus packages stemming from the pandemic. Whatever the reason, the economy has a resilience which is befuddling forward-looking indicators, and it now looks like the Federal Reserve will possibly start lowering the Fed Funds rate when it meets next month.  Ultimately, this action alone will not become stimulating but will instead be less resistant to the current economic expansion.

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