Why traditional economic indicators failed so many this cycle
Investment News by Brett Ewing and Lance Mitchell
Many economists hold the belief that a recession is still a possibility, which has been stoked by the breakdown in traditionally reliable economic indicators. These include economist favorites like the Industrial Production Index (IPI), the Baltic Dry Index (BDIY), the Change in Labor Market Conditions Index (LMCI) and the price of copper.
But are these long standing indicators really accurate?
We believe that indicators like the BDIY and copper have been rendered completely useless by the effects of the dollar, the oversupply of product and the current en vogue switch to service based economies across the world. The two most obvious examples of this significant shift are China and Saudi Arabia. Each of these countries’ governments has realized the need and benefit of growing their impoverished middle class through the services sector instead of the highly volatile commodity and manufacturing sectors.
And both countries have now begun the difficult and painful process by moving sovereign investments away from these areas, which only adds to the harm already being created by the dollar on the effectiveness of indicators that capture almost exclusively commodity related growth.
Further, the IPI, which is the stalwart indicator for many economists, has been flashing bright red recession lights for months now. But unfortunately, this index is also disproportionately set towards industries that continue to be in great depression level downturns, yet represent little in the way of the makeup of our current service based economies. And its reliability is further compromised by a shifting and more efficient power grid and the prevalence of utility output as a component.
In contrast, we think that the Chemical Activity Barometer, which was developed by the American Chemistry Council, to now be a far superior leading indicator to industrial production. It grabs items with more pertinent data for the makeup of the economy we now find ourselves in today. The “CAB” has been found to consistently lead the U.S. economy’s business cycle given its early position in the supply chain versus a large metal and mining focus in the Industrial Production numbers.
The CAB has been showing strong year-over-year growth and has been accelerating in the past few months. This is a very good sign for an eventual pickup in the more lagging IPI number.
Finally, we come to the recently ugly looking LMCI which is a Fed favorite used to gauge the health of the jobs market. Over the past few months this index has been trending down and worrying many market participants, as well as the Fed.
There are plenty of explanations for this. First, the working-age population is growing very slowly now that the two largest generations, Millennials and Baby Boomers, are very solidly already in the number. Second, the labor force participation rate will have a hard time growing substantially until lower income wages increase enough to get people excited about working again.
That’s why we think the trajectory of payroll employment will continue higher at a steady, although slower, pace with 100k plus months being the exception and not the norm.
The bright spot in the employment picture continues to be wage growth,which for the last several years seem to focus on the very skilled higher paying jobs, but is now proliferating down to the lower income works. These higher wages for lower income workers, accompanied by minimum wage increases, could not only put more money in workers’ pockets, but also help the labor force participation rate as well.
The economic table as it is currently set, shows a lower growth, but incredibly stable environment, but only if you interpret the data with the strong dollar in mind.