Wednesday, May 28, 2008

Week of May 19, 2008--What Does the Future Hold?

“I never think of the future, it comes soon enough,” said Albert Einstein. Even so, economists still love to forecast future business activity. And, there are some fairly reliable indexes that help to predict such activity. The best is perhaps The Conference Board’s Index of Leading Economic Indicators (LEI) that we have mentioned in past columns, which attempts to predict 6 months to 1 year ahead. The Conference Board also has a “Coincident” index with 4 indicators that mirror current economic conditions. Economists use the same 4 indicators to determine if we have entered a recession.

The Conference Board’s Coincident Index is currently split right down the middle. Two of its indicators—personal incomes and manufacturing and trade sales—increased in April, while industrial production and employment were shrinking. We cannot therefore say we have entered a recession.

The LEI that predicts future activity itself is made up of 10 indicators, and is slightly positive. The index rose 0.1 percent for the second straight month, after declining for 5 straight months. Six of its ten components were positive, beginning with higher stock prices. Its six-month average rose to a minus - 1.2 percent from a minus - 2.4 percent. It has therefore been predicting slightly negative overall growth this year.

The fact that the LEI (i.e., future growth) is still negative, while the Coincident Index is flat usually means we are still at the top of the last business cycle. So either slow growth continues, or a recession could still be in the works.

Another good indicator not part of the LEI is the National Association of Realtor’s pending existing-home sales index. It measures home sales under contract but not yet closed, so it is a predictor of future closed sales. March pending sales rose 12.5 percent in the Northeast, but continued to fall in other parts of the country. Overall, pending contract activity is down 20 percent in 12 months.

Of course, economic activity also depends on the inflation picture, which has been eating away at personal incomes and so consumer spending. The Consumer Price Index is still running at a 3.9 percent annual inflation rate, while the Producer Price Index for wholesale goods that go into consumer goods and services is up 6.5 percent.

And that has drained consumers’ pocketbooks. Outside of food and energy, for example, consumer spending was the weakest in 13 years last quarter, says Business Week. This is in fact helping to keep inflation from rising further. So-called ‘core inflation’ without food and energy prices, has risen just 1.2 percent in the past 3 months.

Higher inflation is perhaps the major reason that the Federal Reserve will not lower their short-term rates any further at present. When interest rates are below the inflation rate, monetary policy becomes very stimulative, which is inflationary, as we said in our last column.

Inflation is also fuelled by consumers’ expectations of future inflation. What in fact drives up prices is that consumers are willing to spend more, but only if they have the money to do so. So it really looks like those soaring food and energy prices have brought economic activity to a standstill. We will study its effect on home sales in our next column.

© Harlan Green 2008

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