Regular Pay Me Weekly readers know that the Conference Board's Index of US Leading Economic Indicators (LEI) is one of my favorite quick measures of US economic prospects. I offered a detailed rundown of the LEI and all of its components in the Jan. 30, 2009 issue, Follow the Economy's Lead, and then updated that analysis in the Feb. 20, 2009 issue, It's Still the Economy.
The fate of the US economy and the duration of the current downturn remain key to the performance of global stock markets; I've made an analysis of LEI a monthly feature of this e-zine. Since the latest reading was released Thursday, Mar. 19, 2009, it's high time we took another look.
First up, here's a chart of the year-over-year change in the US LEI.
I don't seek to overcomplicate this indicator. My basic rule remains: When the LEI year-over-year change is negative the US is or will soon be in recession, and when it regains positive territory the US is likely seeing a recovery.
The indicator has been in negative territory since late 2007, and at -3.6 percent is trading at a level consistent with a severe recession. This is behind my call that the current downturn will be the worst for the US since the early 1980s. This isn't a quick, V-shaped pullback such as we saw in the early '90s and again in 2001.
The current level for the LEI is 98.50, and at the end of January it was at 98.90. The LEI fell by 0.4 in February, slightly less than analysts' consensus expectations. That said, the gain in LEI for the month of January was revised from up 0.4 to up just 0.1 percent; overall the report was just about in-line with expectations.
Let's start with the bright side: Six of the ten LEI components were positive in February. That said, only four of those were just barely positive to neutral. Leading the upside was the interest rate spread indicator--check out my chart below for a closer look.
As I explained in Follow the Economy's Lead, this measures the different between the yield on a 10-Year US Treasury bond and the current federal funds rate. This is essentially a measure of the steepness of the yield curve.
In February, the yield on the 10-year government bond rallied somewhat from extremely depressed levels that prevailed at the end of January while the fed funds rate remained ultra-low. This indicates that monetary policy in the US is extremely loose and accommodative; for reasons I explained at depth in the Feb. 27, 2009 issue, The Money Super-Accelerator, monetary policy isn't as effective as it normally would be thanks to the ongoing deflationary impact of the credit bubble and bust.
It's also worth noting that the Federal Reserve now intends to pursue a policy of quantitative easing--buying US Treasury bonds directly with what amounts to printed money. When that policy was announced earlier this week, the yield on the 10-year government bond plummeted from about 3 percent to below 2.6 percent.
Assuming this move largely holds, which I suspect it will, the Fed's effort will totally take back the gains in the interest rate indicator for March. In other words, the biggest tailwind for the LEI in February is almost certain to become a significant headwind in March.
The second most supportive indicator within LEI last month was vendor performance; see my chart below for a closer look.
This index shows the speed at which companies receive deliveries from their suppliers. When delivery speed slows, this index rises.
If you're a company producing a product and it takes longer for you to get supplies, it likely means your suppliers are struggling to meet demand and are experiencing delays. They may even be running up backlogs of unfilled orders as they attempt to find ways to boost production.
A sustained rise in this indicator would suggest a recovery in the US manufacturing sector. However, the indicator has bounced from extremely distressed levels, and one month of gains hardly indicates a trend. Moreover, all of the other major surveys of manufacturing activity in the US indicate a continued contraction. In other words, I'm not going to read too much into this indicator's bounce unless it's sustained for another month or two.
For the past few months, strong growth in the US money supply has supported LEI; this month money supply growth was only a marginal positive for the index. This, too, won't last for long--the money supply should resume its strong rate of growth thanks to continued efforts by the Federal Reserve and Treasury to prevent outright deflation.
Of the four indicators within LEI that fell last month, consumer expectations, jobless claims and stock prices were the biggest drags. I doubt it's necessary for me to throw up a chart of the S&P 500 as I'm confident Pay Me Weekly readers are all too aware of the fact stocks fell in February.
After a steep drop early in the month, the S&P 500 has recovered sharply. As of this writing, the index is up about 5 percent for March. If the rally holds through the end of the month, as I expect it to, this indicator will become a marginal positive for LEI when March data is released at the end of April.
The situation with jobless claims looks ugly...really ugly.
As you can see, this indicator is approaching 650,000, a level unseen since the early '80s. The jobs market shows little sign of a recovery, and I suspect this will be one of the last indicators within LEI that will actually improve.
The reason is that companies often hold onto employees until well after a downturn starts--labor hoarding. And employers also seem to overdo layoffs during the height of downturns, and then have to hire back workers once the economy stabilizes.
What I'm watching for is some sort of a stabilization or slight moderation in this data that might suggest the pace of layoffs is slowing. So far in March, however, we haven't seen that, as the weekly data is hovering around 650,000.
Finally, let's look at consumer expectations.
Consumers remain gloomy in the US, and there's no sign of a turn, though this indicator can be volatile from month-to-month. Also, there's a strong correlation between the state of the jobs market and the state of expectations, so my comments above are just as applicable here.
I suspect that if the stock market continues to rally in March and gasoline prices remain relatively low, we could see somewhat of an up-tick in consumer expectations this spring. But the timing and durability of any such bounce are far from certain.
Bottom line: I wish I were able to write that I see the beginnings of a turn in the LEI, but that's just not what the data is telling us. I'll need to see some sort of a sustained recovery in this indicator--driven by more than just rapid growth in the money supply and lax monetary policy--before I call an end to the recession. Looks like we'll have to wait at least another month for that.
Of course, not all of the news is bad. As I highlighted in my energy-focused subscription newsletter The Energy Strategist this week, there are some signs that global commodity markets are beginning to turn. This upside will be driven by a continued recovery in the Chinese economy and continued tight global supplies. As I noted in The Energy Strategist:
This chart shows the year-over-year change in Chinese electricity production for each month going back to the beginning of 2007.
Source: Bloomberg, The Energy Strategist
These figures can be skewed from month to month by factors such as weather events or shutdowns of major plants for refueling or maintenance. The important thing is the larger trend.
It's clear that year-over-year growth in Chinese electricity production was strong for most of 2007 and into the first half of 2008 and then decayed rapidly after midyear. Electricity production actually shrank sharply in the fall. The glimmer of light at the end of the tunnel is that Chinese electricity demand grew again for the first time in months in February. This signals an uptick in manufacturing activity, and probably consumer spending as well.
And we can measure China's import demand by monitoring global shipments on dry bulk carrier ships. Dry bulk carriers are used to transport cargos such as coal, iron ore and grains.
Source: Bloomberg, The Energy Strategist
This chart shows the total number of dry bulk fixtures set each month. This isn't the total tonnage, but the number of ships chartered.
There's significant month-to-month variation, due to various factors such as the negotiation of prices for various commodities. However, there was a pronounced and sustained drop in dry bulk fixtures between mid-summer and December. That said, fixtures rebounded in February, hitting levels unseen since June 2008.
The March data (highlighted in red) looks light at first glance, but remember the month is only a little more than half over. If the pace of fixtures continues, March will shape up at least as strong as February. Although data on exactly what these carriers are transporting and where it's going isn't always available, it's fair to say that many of these fixtures are a direct result of a pickup in Chinese commodity import demand.
Each of these factors and data points means little in isolation. But together they establish a simple picture: Declines in global oil supply (production) are beginning to catch up to the decline in global demand.
In other words, the main dynamic driving crude oil since last summer was that a rapidly deteriorating global economy spelled a big percentage decline in oil demand, particularly in the developed world. In the US the pace of decline in demand reached record proportions in the fall.
On the supply front, OPEC responded to falling prices by cutting output, slowly at first and then more aggressively moving in to the final months of 2008. Outside OPEC, most projects would have remained on reasonably solid footing financially until sometime in early November when oil first breached the USD70 level. After that, as oil fell steadily so did the decline in drilling activity and production.
It took some time before the pace of production declines began to match up to the pace of demand destruction. The signals I outline above suggest we're now at this tipping point. Even better, there are some signs that global oil demand is stabilizing. This sets up the potential for a particularly bullish scenario: The fall in oil supply looks to be accelerating just as demand begins to revive.
And crude oil is far from the only commodity showing signs of recovery. In his recent issue of Commodities Trends, futures guru George Kleinman takes a closer look at the global soybean market. And in a post on the free blog At These Levels, This time It's not Different, I take a look at the potential for a huge move in the US natural gas market.
In closing I would like to invite all readers to visit our free blog At These Levels. Please feel free to comment on our posts and ask questions. You can also do this by sending me a message via Twitter @Elliott_KCI.
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