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Happy new year? Maybe not. There are growing signs of a mild recession during the first half of 2023.

Each month, we are inundated with so many data points that attempt to gauge the health of the domestic economy. One of the more useful, albeit often under-the-radar, measurements is the Conference Board’s U.S. Leading Economic Index (LEI).

LEI: A predictor of economic growth

According to the Conference Board, the LEI aims to signal peaks and troughs in the business cycle for major economies around the world with a typical lead time of seven months. The index has 10 metrics, among which are manufacturing hours worked, building permits, the S&P 500, interest rate spreads and surveys of future conditions. Most leading indicators, as of the October 2022 report, have a negative six-month trend.

Chart titled "Most Signs Point to a Weaker Economy in 2023” shows the Leading Economic Index components as of October 2022. Leading Credit Index, S&P 500, Interest Rate Spread, Consumer Business Expectations, ISM New Orders and Building Permits have a weak monthly change and a negative 6-month trend. Average Weekly Hours has a neutral monthly change and a negative 6-month trend. Nondefense New Orders and Consumer Goods New Orders have a neutral monthly change and a stable 6-month trend. Unemployment Claims has a weak monthly change and a stable 6-month trend. Source: Ally Invest, Bloomberg, The Conference Board

The Conference Board’s Coincident Economic Index suggests the economy is on solid footing, evidenced by healthy monthly job gains, high personal income (though not after inflation), near-record levels of industrial production and mixed manufacturing data. LEI, though, is trending down with rising unemployment claims, falling manufacturing new orders and a worse leading credit index.

Understanding economic data types

It helps to recognize that economic data can be leading (forward-looking), coincident or lagging (backward-looking). For example, the Consumer Price Index (CPI) is a lagging indicator, as is the monthly jobs report. Those pieces of data, while quite important, should always be taken with a grain of salt since they don’t capture what might currently be happening in the economy and what lies ahead.

Economic temperature check: Hot or not?

The LEI’s forward-looking nature is what makes it important – particularly when the economy is in a transition phase. Right now, GDP appears robust. Just take a look at the Atlanta Fed’s GDPNow model for Q4. At 2.8 percent, it suggests the economy is expanding at an above-trend rate. This comes after negative growth in the first two quarters of 2022. Looking ahead, though, the consensus forecast calls for a minor economic contraction during the first half of 2023. That outlook is driven, in part, by what the LEI reveals.

October LEI’s big red flag

On November 18, the October LEI report showed an eighth consecutive monthly drop. Ataman Ozyildirim, senior director at The Conference Board, remarked that the U.S. economy is possibly in a recession following the release. Causing the more dismal economic outlook were some of the LEI’s non-financial components. Average consumer expectations for business conditions and the ISM Index of New Orders accounted for more than half of October’s 0.8 percentage point drop.

Poor LEI often portends a recession

The LEI is important as its year-on-year change is correlated with how the broad economy may soon fare. Since the late 1960s, each of the past eight U.S. recessions was preceded by a negative annualized LEI percentage change. That is a sobering statistic since the LEI is currently down nearly three percent from 12 months ago. In fact, the Conference Board suggests a U.S. recession is likely to begin at the turn of the year and last through mid-2023.

Future stock market performance and LEI

Unfortunately for the bulls, with the LEI down 3.2 percent from six months ago, that puts it in the second-worst decile since 1988. Historically, such a weak LEI change has led to relatively poor S&P 500 returns in the coming three, six and 12 months. Of course, in this instance, stocks have already fallen considerably from their early 2022 high.

Chart titled "Poor stock returns ahead? LEI currently in the 2nd-worst decile (most bearish)” tracks S&P 500 forward returns by LEI trailing 6-month percentage change since 1988. The S&P 500 forward return values for the LEI 6-month percentage change 2nd-worst decile are –0.6% (3-month), -0.5% (6-month) and –0.5% (12-month). Source: Ally Invest, Bloomberg, The Conference Board

The bottom line 

There may be tougher economic data in the coming months. But don’t let that steer you from a long-term routine investing plan that is centered around dollar-cost averaging in down markets. It’s hard to predict when the exact bottom in stocks will occur. Staying the course is a good approach after an already volatile year.