The Economic Indicator Handbook. Richard Yamarone

– considerably more timely than the quarterly report on GDP – and that it takes several difference barometers to ultimately determine expansions and contractions.

      When the economy is growing, economists refer to this phase as an expansion. Traditionally, aggregate demand advances due to several variables such as population, technological advances, and abundance of natural resources. Policies enacted by legislatures often determine the growth rate as well. In the United States, the base trend in economic growth – as measured by inflation adjusted, or real, gross domestic product (GDP) – has been positive, advancing an average of 3.2 percent since 1948. This is somewhat of a benchmark to consider when thinking of the condition of the economy.

      Contractions occur less frequently – thankfully – and are often engendered by falling corporate profitability, widespread labor market weakness, escalating prices, or some other event. Rarely do economic expansions simply run out of gas. Either monetary policy makers choke off growth by aggressively increasing borrowing costs or fiscal policy makers fail to provide sufficient stimulus in the way of federal spending initiatives like infrastructure projects or by tax reductions. So-called economic shocks like an unforeseen surge in energy prices or unanticipated wars, conflicts, or skirmishes have been known to rattle underlying confidence in an economy and reduce growth.

      The National Bureau of Economic Research (NBER) is the official arbiter of the business cycle in the United States. The NBER is a nonpartisan, nonprofit, private economic research institution founded in 1920 studying and analyzing a variety of economic topics. However, its work with respect to the business cycle seems to garner the most attention.

      The NBER's Business Cycle Dating Committee – a group of highly esteemed economists – employs a number of economic indicators used in the determination of economic expansions and downturns.

Basically, the period from a peak in activity to the bottom, or trough, is called a recession, while the phase existing from the trough to the peak is called expansion. There is no single barometer used in the estimation of the particular date of recession or expansion, but rather a compendium of measures that have been known to represent the trend in total economic activity in the country. One of the most commonly used representatives of the business cycle is gross domestic product. While the NBER does in fact observe trends in this indicator, it also uses several others in the dating of business-cycle turning points. Exhibit 2.1 represents a handful of those indicators, including industrial production, real personal income less transfer payments, employment (payroll and household survey), average weekly hours worked, and real manufacturing and trade sales.

Exhibit 2.1 NBER Recession Indicators (Y/Y%)

      Source: Bloomberg

      No two business cycles are the same. As illustrated in many of the exhibits in this book, the length of expansions and recessions have varied widely – although the former, especially recently, have generally been longer and steadier than the latter. The NBER has identified and dated the peaks and troughs in the U.S. economy back to 1854.

      Since then, expansions have ranged from 120 months (April 1991 to March 2001) to 10 months (March 1919 to January 1920), and downturns from 43 months (August 1929 to March 1933) to 6 months (January 1980 to July 1980). The amplitude of the peaks and troughs has also differed significantly from cycle to cycle.

      Leading, Lagging, and Coincident Indicators

      The Conference Board publishes a monthly report called U.S. Business Cycle Indicators, which contains three composite indexes and a detailed report regarding the latest trends in the business cycle. Economic indicators are classified according to how they relate to the business cycle. Those that reflect the current state of the economy are coincident; those that predict future conditions are leading; and those that confirm that a turning occurred are lagging. The Business Cycle Indicators report has the most respected measures of these three phases of the cycle.

Coincident Indicators

The Conference Board's Coincident Economic Index (CEI) is a composite measure comprised of four components that depicts the trends of the current business cycle (Exhibit 2.2). The four components of the Conference Board's CEI are the number of employees on nonagricultural payrolls, personal income less transfer payments, the industrial production index, and manufacturing and trade sales.

Exhibit 2.2 Conference Board Coincident Economic Index

      Source: Bloomberg

      The CEI is not a market mover, and it is rarely reported in the business press. Since it is not intended to estimate or project the future direction of the economy or an industry, most investors ignore it. The true value of this indicator lies in its lengthy history and accuracy as a current measure of the business cycle.

      Each of the components is an excellent measure of economic conditions individually, but when used in concert as a composite, the power to identify peaks and troughs is strengthened. Since a single indicator may emit false signals due to weather fluctuations, calendar or seasonal quirks, or any host of reasons, a composite is preferred, as all of the components would have to be distorted or influenced to result in an improper or misleading reading.