Keep a Watchful Eye on the LEI!
After an awful August that saw the S&P 500 slip roughly 2% lower, stocks rebounded, closing out September with solid gains.
Stocks are now within striking distance of new highs again.
Fundamentally, there are several factors aiding the market, including strong internal market breadth. This due to the NYSE advance-decline line making a series of new all-time highs in recent weeks.
Stock prices typically follow positive breadth to new highs.
Plus, some economic data have taken a decisive turn to the upside, as you can see in the chart above. The Citigroup U.S. Economic Surprise Index measures the degree to which recent economic data have exceeded or fallen short of estimates.
When the line moves up, as it is doing right now, it shows plenty of positive surprises in the economic data. This is a bullish sign for stocks long term. An improving economy most often leads to higher stock prices down the road.
But… (Does there always have to be a “but”?)
For the stock market to break out decisively to new highs it’s going to need additional support from the economy, namely an improvement in leading indicators.
The U.S. Leading Economic Index (LEI), published monthly by the Conference Board, has stalled recently. There was zero change in the index in two of the last three months, including the most recent data release for August.
This is significant because an economic recession has often followed a peak in the leading index, typically by an average of about 12 months later. With the leading indicators appearing to be flatlining now, the clock may already be ticking, counting us down to the next recession.
In the chart below you can see the lack of upside momentum in the leading indicators.
You can see, circled in red above, that the six-month rate of change in the leading index sank to negative 5% just before each of the last two recessions, in 2001 and again in 2008.
Right now the six-month rate of change remains positive. No need to hit the panic button just yet. But you can see that in late 2000 and late in 2007, the leading index deteriorated quickly into negative territory in just a few months’ time.
Which way do we go from here?
Too soon to say, but the direction is critical. A rapid decline in the leading indicators means a recession and lower stock prices.
A rebound in the growth rate likely supports higher share prices ahead.
Bottom line: We need to keep a watchful eye on the leading indicators in the months ahead and act accordingly if either of the two scenarios above begins to prove more likely.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch