Varied Leading Indicators Increase Downside Risks

Nov. 13, 2015
Mixed signals from leading economic indicators make it hard to predict when deceleration in the U.S. economy will abate, but positive signs lead ITR Economics to maintain its positive outlook for the economy in 2016.

The leading indicator input for the future is more varied than normal. Some indicators are throwing off positive signals and other inputs are negative. It is disconcerting when this happens, which fortunately is not often.

The bottom line is that although our forecast for the overall economy in the U.S. has not changed, there are increasing downside risks regarding the timing and intensity of the current cycle that we continue to monitor carefully going forward. For now, U.S. industrial production is on track with our forecast predicting growth of 2.1 percent this year, followed by 3.2 percent expansion in 2016.

One of the key input indicators, the ITR Leading Indicator, fell in October for the third straight month. The ITR Indicator leads U.S. industrial production, our benchmark for the U.S. economy, by eight to 12 months. The decline in the data does raise a concern for our current forecast for U.S. industrial production. Our analysis has shown that negativity in the financial markets is dragging on the ITR Leading Indicator as a whole.

Despite downturn in this indicator, there are other signals from the economy that confirm our expectation that the second half of 2016 will be better than the first. The Chicago National Activity Index six-month moving average (a nine-month leading indicator to U.S. industrial production) is above its June 2015 tentative trough. Robust growth in some of the best indicators of consumer activity (housing starts in double-digit growth and retail sales growing at a 2.4 percent annual rate) also signal a strong consumer that is likely to drive accelerating growth in U.S. industrial production by mid-2016.

Single-family housing starts (see chart above) totaled 703,000 units for the 12 months ending in September, up 10.4 percent from a year ago. The moving total for the last three months is up by 14.5 percent over the same period last year. This is a positive signal that reflects accelerating growth. Furthermore, the inventory of houses is only enough to satisfy 4.7 months of sales (seasonally adjusted figure). This reflects a tighter supply than the 6-7 month inventory indicative of a balanced market. As a result, single-family housing starts will expand at a faster pace in 2016 than in 2015.

The 12-month moving total for multi-unit housing starts was 392,000 units in September, 10.4 percent higher than a year ago. This construction segment is getting a boost from a New York law that was on the verge of expiration in June, incentivizing many new projects. We expect the impact of this event to be positive through the remainder of the year as contractors break ground on projects for which they pulled permits in June.

Existing home sales are also doing well. The 12-month moving average for this series stood at 5.2 million units in September, up 6.4 percent over the year-ago level. The three-month moving average, at 5.5 million units, was the highest it’s been in eight years. This positive trend must be taken in context, though; activity in this market is much lower than the 7 million units of existing homes that were sold in 2006, prior to the housing market crash.

We are also getting positive signals from leading indicators outside of the housing market. The 12-month moving average for corporate profits for non-financial industries reached a record high of $1.55 trillion in the second quarter of this year, 14.8 percent higher than the second quarter of 2014. The fact that non-financial companies are so profitable supports our outlook of improving economic growth in 2016.

In oil and gas, extraction reached its peak earlier this year in the U.S.; monthly data stopped rising in April. We expect that production will slow further in the near term, which will help stabilize oil prices in the coming months. In the meantime, the three-month moving average for WTI oil prices fell to $46.96 in September.

Consistent with our downgraded outlook for China, which will result in lower global oil demand, we have revised our outlook for oil prices. The new forecast calls for prices to rise to no higher than the low $60s by the end of 2016. Lower oil prices for a longer period of time will have a net positive effect on the U.S. consumer, which we believe will be the driving force behind the economy’s expected acceleration next year.

There are mixed signals coming from the new orders series as well. Non-defense capital goods new orders, which are representative of overall business-to-business activity in the U.S., slowed to 0.1 percent growth in August. Impending recession will be mild and short-lived. With profits and expenditure plans on the rise, it is unlikely that negativity in the business-to-business segment of the economy will extend into the second half of next year. Our forecast calls for business-to-business activity to shrink by 3.0 percent this year, but resume growing in 2016 and expand by 8.4 percent for the year as a whole.

Industrial machinery new orders for the 12 months through August are down 11.3 percent, totaling $32.3 billion. However, the quarterly trend ticked up 1.6 percent in the three months through August. This is an early indication of recovery. Industrial machinery new orders will end 2015 down 7.8 percent (12-month moving total). They will subsequently rise out of recession and accelerate through 2016, but return to slower growth in 2017.

There are some positive signs in other sectors as well. Heavy truck production over the 12 months ending in September is up 19.8 percent on a year-over-year basis. Ship new orders are in recovery and internal trends indicate there is further improvement ahead. Most encouraging is that small business capital expenditure plans are up 4.8 percent on an annual basis in September. If small businesses, which make up nearly 94.0 percent of the manufacturing sector in the U.S., are planning higher capital investment, it is a positive sign for new order activity in the coming quarters.

Automation suppliers are facing a lot of headwinds right now, particularly those that serve the industrial machinery, oil and gas, and other commodity-related markets. A strong U.S. dollar, lower market demand and significant volatility are all contributing to what is turning out to be a difficult 2015.

There are mixed signals coming from leading economic indicators that make it hard to predict with certainty when the deceleration in the U.S. economy will abate. However, there are some positive signs as well. These positive signs are mainly related to the U.S. consumer, whose spending accounts for roughly 70 percent of the U.S. economy. It is the financial stability and expected increased purchasing activity of the consumer that leads ITR Economics to maintain its positive outlook for the economy in 2016, even if the pickup doesn’t occur until later next year than originally expected.

>> Alan Beaulieu, [email protected], is president of the Institute for Trend Research (ITR). The ITR blog can be found at

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