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The way the markets are acting these days, you never know whether the next piece of news will be good or bad. But rather than looking to the stock or bond markets to try to figure out when the economy might finally start to recover more strongly, there's a useful indicator you can turn to for help.
One of economics' goals is to find information that reliably predicts which way the economy is headed in the coming months and years. In this month's brand-new issue of Rule Your Retirement, which is available to subscribers this afternoon at 4 p.m. ET, Foolish financial planning expert Robert Brokamp takes a look at what the future may hold for the economy.
One of the measures that Robert turns to in this month's Rule Your Retirement comes from The Conference Board, a nonprofit organization that seeks to give companies the information they need to make informed business decisions. It developed the index of leading economic indicators, or LEI index, to help investors and business leaders map out where in the business cycle the economy is at any given time.
Understanding the LEI index
The LEI index uses 10 different datapoints that tend to move in advance of the overall economy. You can group them into three broad categories:
- Financial data include interest rate spreads between short- and long-term rates, money supply, and stock market performance.
- Measures of production activity include building permits, supplier deliveries, average manufacturing hours, and new orders by manufacturers for consumer goods and capital goods.
- Measures of consumer activity include weekly unemployment claims and consumer expectations.
Each factor is given a certain amount of weight in the index. The two biggest factors are money supply and average weekly hours, manufacturing.
Over the past several months, the LEI index has behaved just like you might have expected it to given the up-and-down economy, featuring a mix of strong, weak, and flat performance. But in September and October, the index put in two consecutive upward moves of 0.5%, suggesting that economic growth may be accelerating.
Drill down on the most promising stocks
As useful as the LEI index can be as a measure of general economic activity, it can also help you figure out which sectors may perform best in a given market environment.
For instance, looking closely at October's readings, interest rate spreads are giving the LEI index its biggest push upward. That bodes well for big banks Bank of America (NYSE: BAC ) , JPMorgan Chase (NYSE: JPM ) , and Wells Fargo (NYSE: WFC ) , which all profit when they can pay depositors very low amounts of interest and turn around to loan that money out at significantly higher rates.
Conversely, supplier deliveries have been the biggest drag on the LEI index in recent months. That indicates that suppliers aren't facing high demand from manufacturing purchasers, weighing against production growth. Yet we've seen higher commodities prices in several markets; retailers Abercrombie & Fitch (NYSE: ANF ) and Liz Claiborne (NYSE: LIZ ) have struggled with higher cotton prices, while Starbucks (Nasdaq: SBUX ) and Kraft Foods (NYSE: KFT ) have increased their prices on coffee to try to pass on their higher supply costs. The odd combination suggests that supply constraints are driving commodities prices more than strong demand.
How to invest
Even with the LEI index overall on the upswing, you shouldn't necessarily run out and buy stocks right now based on it. But Robert does think the bond market will see big bumps in the near future, and urges those who need liquid assets to accept near-zero interest rates on cash investments rather than risk losses by reaching out the maturity curve for yield.
The LEI index is just one measure Robert discusses in this month's Rule Your Retirement. To learn more, you'll want to see the whole issue -- and that's as easy as clicking here to sign up for a free 30-day trial, which gives you no-holds-barred access to all of RYR's resources.
The key takeaway, though, is that as pessimistic as things may sound for the economy, there are signs that a recovery is taking hold. Smart investors are already planning for the future, and you should be among them.