Friday, May 20, 2011

Divergences Among LEIs

We regularly follow several different types of leading economic indicators (LEIs), often times looking for divergences with the stock market – in either direction. What we’re witnessing today, ironically, is a divergence among LEIs, which makes interpretation more difficult than when they’re moving in a more uniform fashion.

In the chart below (warning – it’s a bit messy) are three of the LEIs that we follow, along with the S&P 500 Index (white line). In general, all three LEIs have risen for the past two years, confirming the bull market in stocks that began in March 2009. Now, however, some potentially concerning breakdowns are starting to occur.

The most disturbing is the downturn in the Citigroup Economic Surprise Index (yellow line), which is a daily gauge of whether economic reports are exceeding or missing consensus estimates. The index has plunged almost to its low from last year, which came on the heels of the Euro debt crisis and subsequent economic slowdown. The main difference is that when this index was at a similar reading last August, the S&P had already experienced a -16% decline and was beginning to bounce, whereas now stock are only slightly below their recent high. So, the current reading can be interpreted in two very different ways – the bullish view being that the market continues to be impressively resilient and confound the pessimists, and the bearish angle being that the Citi Index is foreshadowing another steep decline in stocks that just hasn’t occurred yet.

The other two lines on the chart are much less alarming. The orange line is the ECRI Weekly Leading Index, which has dipped a little recently but not by much. The green line is the Conference Board’s monthly Leading Economic Index, which was released yesterday for April and showed just a minor tick down from March. At the very least, it’s noteworthy that none of the three are still rising, and stocks have at a minimum stalled near their recent highs. But it’s still too soon to know which of the three LEIs is sending the right message.