Thursday, February 23, 2023
The Conference Board’s Leading Economic Index (LEI) for January was released Friday, February 17, 2023. The LEI is an aggregate of 10 economic and market indicators that tend to lead changes in economic activity. The index declined 0.3% for the month and 5.9% for the past year, a slight improvement from the one-year change the previous month. Despite some signs of improvement, the Conference Board noted that their LEI has exhibited the depth, duration, and dispersion that has acted as a reliable indicator of elevated recession risk in the past. (See the Conference Board’s commentary here. For a quick take on the current economic outlook, see LPL Chief Economist Jeffrey Roach’s recent blog here.)
The LEI report left a similar impression as Bloomberg’s latest survey of economists. In the February survey, U.S. and global growth expectations for 2023 had improved but remained tepid. The median estimate of the likelihood of a recession in the next year had ticked down from 65% in January to 60% in February, a positive direction, but still indicating elevated risk. Despite the improvement, a recession remains more likely than not as markets price in more aggressive Federal Reserve policy as it continues to try to tame inflation.
What’s the market takeaway of being in a period of elevated recession risk at current levels? Weakness in leading indicators at roughly the current level have signaled near term risk for markets, with six-month forward returns below average, but looking out over the next year, economic signals may have reached a level where weakness is so readily apparent that it may actually be good for markets in the longer-term. In fact, as shown in the chart below, the current level of the LEI is about where the divergence between historical S&P 500 performance over the next six and twelve months is widest. So indicators suggest choppy markets in the near term but market appreciation by end of the year.
More specifically, we looked at key declining crossovers for the LEI—the one-year change moving below a key level for the first time in over a year. The sample here is small and can be taken only as a rough guide to the potential outlook. Currently, the year-over-year change in the LEI recently crossed below both -5% and -6%, represented by the boxed area below. You can see returns over the next six months (orange line) at this level remain muted, but it is also the level at which returns over the next year (blue line), on average, start to look attractive.
Despite the small sample, we think the assessment of market risk historically related to the LEI is sensible and generally in line with other indicators we are watching. There is some reason for optimism one year out, among them that elevated risk of a recession is near consensus, even if the potential damage for higher rates has not worked its way through the economy yet. But near term equity markets may have come too far too fast and the economic outlook still has downside risk. Looking a year out, we maintain cautious optimism, but history says markets may still have some rough patches to get through on the way there.
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