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The Dow Bounces Back as the Leading Economic Index Strengthens

By Dan Caplinger - Jul 18, 2014 at 11:00AM

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Earnings season is in full force, but economic data is still important.

On Friday morning, the Dow Jones Industrials ( ^DJI 0.00% ) bounced back from their substantial losses yesterday as investors got over their initial shock at the reported shoot-down of a commercial airliner over Ukraine and shifted their attention to earnings season and economic factors. As of 11 a.m. EDT, the Dow was up 84 points, and favorable news from the Conference Board's Leading Economic Index helped bolster the Dow. Yet despite generally solid performance, the report suggests some winners and losers in the economy, with General Electric ( GE 1.60% ) potentially benefiting, while Home Depot ( HD 0.11% ) could miss out.


Source: General Electric.

Where will the economy lead?
The Conference Board's June figure for the Leading Economic Index rose 0.3%, marking the fifth straight month of advances for the index. The purpose of the Leading Economic Index is to look at economic factors that tend to lead economic expansion, with the idea that when those factors are strong, growth in the economy will follow. Therefore, the consistent gains we've seen in the LEI lately point toward accelerating growth six to nine months into the future.

Beneath the headline numbers, though, you can see some tensions among the different factors that the LEI uses to come up with its overall index figure. On the positive side, strength in manufacturing was one of the most important positive factors, with three different measures of new-order activity signaling continued expansion. Combined with the ongoing favorable spread between short-term and long-term interest rates and the performance of the stock market, manufacturing is in a position to lead the overall economy forward. As a leader in manufacturing in areas from energy to aerospace, General Electric has been one of the big beneficiaries of the renaissance in manufacturing, and its most recent earnings report saw strength in its industrial businesses offset weakness in its financial unit. Moreover, with Boeing having seen huge gains in aircraft sales, General Electric's role in making jet engines and other components for Boeing and other aerospace manufacturers could help drive overall growth in the future.

Yet on the flip side, not all of the LEI's 10 indicators improved. In particular, a drop in building permits was the biggest negative factor in the index, while measures of labor strength also weighed on future prospects. It's interesting that despite all the activity in the manufacturing sector, the average number of hours that workers in manufacturing are putting in has been weak lately. The housing industry, though, appears to be the focal point of concerns about future growth, as rising prices could eventually make homes unaffordable for would-be home-buyers. That in turn would make things more difficult for Home Depot, which relies on demand from home buyers as well as building contractors. Permits are notoriously volatile, though, so it's premature to conclude that Home Depot's future is growing dimmer.

As earnings season continues, Dow investors will increasingly focus on individual stocks. Yet the strength of the economy will still be a key determinant in the stock market's long-term moves. The LEI provides a look into the future, and while it's far from perfect, being prepared for what could come down the pike can give you an edge over those with less foresight.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$35,227.03 (0.00%) $0.00
General Electric Company Stock Quote
General Electric Company
GE
$97.55 (1.60%) $1.54
The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
HD
$416.18 (0.11%) $0.48

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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