Bonds: How Strong Is The Economy?

The Index of Leading Economic Indicators is showing potential economic weakness in the months ahead. The chart below shows the LEI for the last 15 years. The LEI peaked out in January 2006 at 139.1. The levels for February, which were just released, show a reading of 137.3. This index is a good indicator of economic strength over the next 4-6 months. The weakness in this indicator would suggest slower growth or weakness for the balance of 2007.

The LEI is composed of 10 different components. The different components are listed below with both their weighting in the index and their contribution to the last reading of LEI. The Conference Board releases this data about 3 weeks after the end of the previous month.

The largest contributors to the LEI are the Money Supply and the Factory Workweek. These 2 components account for about 60% of the value of the LEI. Recently, there has been much talk in the press about the housing market and whether the weakness in housing will drag down the rest of the economy. This sector of the economy is measured by Building Permits which accounts for only 2.7% of the LEI. However, most of the focus of economists and the press has been on housing. Now, their attention is moving to high defaults in sub-prime mortgages, and possible tightening of credit conditions for new home buyers.

Let's look at the LEI and some of the other components of the index. Last month, 5 of the 10 measures showed weakness in the economy. These measures were: the yield curve, vendor performance, initial jobless claims, consumer expectations, and building permits.

There is value in following the LEI and all of these components. The weakness in the index is not coming from only 1 sector of the economy (housing), but is shown in several of the individual measures of future economic growth. There are several economists calling for the economy to pick up later in the year. (These economists are obviously not paying attention to the LEI). We feel this is unlikely, and expect the economy to continue to slow. This should provide a favorable backdrop for bonds.

All data shown above is from the Conference Board which releases the Index of Leading Economic Indicators.