At Pinnacle we are in the business of assessing incoming economic data, and I can say that it’s becoming tougher by the day as many analysts begin to question the efficacy of economic models that have largely worked in the post-WWII period. A great example of this is the message coming from the Conference Board’s Leading Economic Indicator. This indicator, which consists of 10 different economic variables (shown below) that have traditionally led the economy, has actually increased in the last few months, despite a lot of other negative data building around it.
When one digs inside the numbers, it’s not hard to see that a very large rise in money supply along with a steep yield curve have propped up the reading of the overall index recently. Normally these two indicators should be great harbingers of a healthier economy, but right now, I’m not so sure about that. Many analysts are arguing that money supply is rising quickly due to chaos in Europe rather than as a reflection of a healthy banking system. Analysts are also quick to point out that the yield curve is only steep because we live in a world where the Federal Reserve has pegged short-term interest rates at zero.
The point is that many models that are used by investment firms were built to work based on the cycles of the past couple of decades. However, the post-financial crisis world we now live in contains structural problems that may be overriding some of the old economic bellwethers that could be relied on to predict the future direction of growth. In short, it may be time for investment professionals to consider adjusting their models to account for the current environment. And for those who also attempt to read the economic tea leaves as we do, well I guess we can expect more bags under our eyes as we wrestle with whether or not we are in the midst of profound changes in the way to look at the economy going forward.
