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Flashback: Signs of Stronger Economy

No. 20, 2006, NEW YORK (Dow Jones)--The index of leading indicators increased for the second month in a row in October, a tentative sign of better economic times ahead.

Moreover, the Economic Cycle Research Institute's weekly leading index, which gives a more up-to-date view - moved further into positive territory in the week ended Nov. 10, for the second week in a row.

"We've still got lackluster growth between now and early 2007, but the risk of recession may be receding," said Lakshman Achuthan, managing director of ECRI in New York.

If Achuthan is correct and there is a fading chance of a recession and lessened threat from inflation, then he could also be right when he states that "the Federal Reserve may stay on hold for a lot longer than people think."

The Changed Nature Of Leading Indicators

Composite leading indicator indexes have fallen into some disfavor with financial markets, possibly for two reasons: (1) markets are more focused on specific sectors that may be the chief sources of economic weakness, currently housing market indicators, at other times manufacturing indicators; and (2) leading indicator indexes are most valuable at signaling cyclical turning points and no such indication has been given recently.

To be sure, the Conference Board index has stuttered in recent months with little clear trend. Over the six months from April through October the index has drifted down by just 0.2%, hardly changed at all.

In October, the index rose by 0.2%, with six out of the 10 indicators up, led by a 0.43 percentage point contribution from real money supply, reflecting both an increase in nominal money supply and a decline in the consumer price index. Based on the decline in the CPI, the Conference Board presumed a decline in the personal consumption expenditures price index which it uses to deflate money supply. Offsetting some of the increase were declines, including a 0.27 percentage point decline in vendor performance and a 0.17 point decline in building permits.

At the same time there were revisions, including a fairly large one to September (now up 0.4% instead of the initially reported 0.1% gain).

Indeed, the tendency for frequent and fairly large revisions may be another reason for the lessened market interest in the leading index. (Three of the components - manufacturers' new orders for consumer goods and materials, manufacturers' new orders for nondefense capital goods and the real money supply - are not fully known and, so, the Conference Board makes imputations for them.)

ECRI's Index More Timely, Less Revised

ECRI's weekly leading index has the advantages of being more timely than the monthly Conference Board indicator. Its seven components are available at time of publication, so, there's less guesswork and fewer revisions.

The favored measure that the ECRI analysts look at to evaluate the index is not the index level itself or its month-to-month change, but rather the change in the index relative to its 52-week moving average.

On that basis, the WLI reached a 2006 peak of +5.0% in the week ended Feb. 10, drifted lower until it moved into negative territory in the week ended July 28, where it stayed for 14 weeks before showing a 0.6% increase relative to the 52-week average in the week ended Nov. 3 and an increase of 1.2% in the week ended Nov. 10.

Just as the early February peak signaled the drift through slower growth in the second and third quarters, the move back into positive territory - if it continues - could signal a return to more trend-like growth by the second quarter of 2007, according to Achuthan.

"The improvement in the WLI is pervasive, it's not just one component," said Achuthan, who looks for signals that are pronounced, prolonged and pervasive. "It takes a while before we can tell for sure, but it's beginning to look like there's something afoot. The WLI is like a one-armed economist."

That seems to mean that the signal is pretty clear.