Leading indicators

Frequently asked questions

• The index fell this month: does this signal a recession?
• How can I increase the lead time?
• I am interested in replicating such an index for the area or province I live in. Can this easily be done?
• How is composite index smoothed?

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The index fell this month: does this signal a recession?

One can only evaluate whether a drop in the composite leading index signals show growth or a sharp dip in GDP by studying the rate of decline in the index, the number of components decreasing, and the recent behaviour of output and employment themselves. The point is that the leading indicator is not a ‘news flash’ estimate of next month’s GDP itself; it is an index describing emerging trends of the direction of the economy, but not the precise magnitude of the change.

Leading indicators are not, in isolation, a fool-proof guide to short-term economic forecasting. Like most data, they are subject to some revisions and to the measurement error of the survey source data from which they are derived. Their relationship to the economy changes over time as the economy itself changes—the growth of services is a case in point. Finally, they are meant to be additional evidence of emerging trends in the economy, and are best used in addition to other economic data provide an overall point of view on the economy.

How can I increase the lead time?

The Daily focuses on the smoothed version of the index using a 5-month moving average. This automatically chops 2.5 months of the lead time. One way to boost the lead time and relevance of the leading indicator immediately is to use only the unsmoothed index.

Analysts who were willing to accept greater risks can also emphasize those components (such as the money supply, stock market and average workweek) with longer lead times.

I am interested in replicating such an index for the area or province I live in. Can this easily be done?

Designing leading indicators at the provincial, regional or city level is very difficult. They are few variables to choose from in a smaller economy and these tend to be affected more by irregular events like strikes or floods or are influenced by a small number of industries or employers whose decisions don’t necessarily depend on the state of the macro economy. Another concern is which dates to compare the leading indicator to, and whether they are available on a regular basis?

How is composite index smoothed?

The smoothed composite leading indicator is the reconstructed composite leading indicator in which the figure for each month is replaced by the average of the composite leading indicator for the four preceding months and the current month. It is the arithmetic average of the five most recent observations of the composite leading indicator. As each new observation is added, the oldest observation is dropped. The advantage of the moving average is that it eliminates the noise in the composite index and emphasizes its trend.