Saturday, January 31, 2009

What Would Signal The Upturn In The Economy?

Today for a change I am not going to write on Telecom. Rather, I would touch upon a subject that is very topical and is of interest to everyone across industries. It is the economy that is being discussed in all social forums, blogs, office water coolers, parties and anywhere where two or more people meet. I am not going to make a forecast or analyze the current situation but would focus on the lead indicators that would indicate any upturn in the economy.

There are many indicators that give us sense on the state of the economy. Unemployment, business investment, GDP growth are all lag indicators which are not pointers to the future of the economy. We end up focusing on the lag indicators as they are easily available and measurable. Unfortunately, the media carries stories about these indicators and we are not able to predict both the uptrend and downtrend in the economy. For example the US economy was in recession since last quarter of 2007 but we got to know about the condition of the economy as late as September 2008. Similarly, I am sure we will not be able to identify the uptrend if we continue to focus on the lag indicators. But the problem is that the lead indicators are far fewer and difficult to measure. Few consider consumer sentiments as a lead indicator but I think the sentiments are based on the lag indicators and hence are not the right measures. I have identified two lead indicators which are not only measurable but are also very pertinent in the current situation.

Baltic Dry Index (BDI)

BDI provides "an assessment of the price of moving the major raw materials by sea. Taking in 26 shipping routes measured on a time charter and voyage basis, the index covers Handymax, Panamax, and Capesize dry bulk carriers carrying a range of commodities including coal, iron ore and grain”. The supply of cargo ships is generally both tight and inelastic — it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the California desert. So marginal increases in demand can push the index higher quickly, and marginal demand decreases can cause the index to fall rapidly. Thus the index indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers. Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as an efficient economic indicator of future economic growth and production

On 20 May 2008 the index reached its record high level of 11,793 points but hit a low of 663 points on 5 December 2008. These low rates move dangerously close to the combined operating costs of vessels, fuel, and crews. The fall was due to subdued commodity demand on lower production activity but it was compounded by lack of credit that resulted in reduction of Letter of Credits (essentially banks had lost faith on each other. BDI is the perfect lead indicator of increased or reduced physical activity especially in case of an uptrend. The index is available at Bloomberg L.P [quote]. BDI has now started to move up and has now crossed 1000 points but still far away from its record highs.

Case-Shiller Index (CSI)

The current crisis has its seeds in the housing bubble of United States. Since the problem started with the housing sector, the economy is unlikely to see an uptrend till the housing sector stabilizes. Stabilization of the housing sector in the US would also imply that the balance sheets of the banks will also find stability on account of sub-prime assets. Hence, I have selected the Case-Shiller Index (CSI) as one of the lead indicators. The Case-Shiller Home Price Indices [S&P] are quarterly nominal house price indices for the United States. The indices are calculated from data on repeat sales of single family homes, an approach, developed by economists Chip Case, Robert Shiller and Allan Weiss. The indices are normalized to have a value of 100 in the first quarter of 2000. The indices are calculated monthly by Fiserv, Inc.- the company that owns and maintains the index and is published with a two month lag on the last Tuesday of every month. Many would argue that his is a lag indicator. It may be a lag indicator in most of the situations but in the present situation, it is very much a lead indicator. Stabilization in the housing prices would signal to other industries that the worst is over. The national index attained its all-time high of 189.93 in 2006 Q2, and has declined in every subsequent quarter to date. This means that the condition of the economy had started to deteriorate much before September, 2008. On December 30, 2008, the index recorded its largest year over year drop.

There may be many more lead indicators which might be relevant in today’s scenario. I would request the readers of this blog to add their lead indicators in the comments section so that we can prepare a comprehensive list of such indicators which would benefit everybody.

1 comment:

Mohit Agrawal said...

I received a number of responses to this post on my email. I would like to thank everybody for their contribution. For the benefit of the readers, I am reproducing the comments below:

James Wallis Martin wrote:
I guess if you consider becoming more efficient, becoming more cost aware, more strategic in resource allocation, and more skeptical of the media doomsayers, then clearly we are already in an economic upturn.

If your business depends on the spending habits of the mindless sheep who believe the media doomsayers, then until the media has something better to "sell" your consumers, there is no hope of an economic turnaround. However, if you can reposition your business to take advantage of the current "media hype" then you will be having the best time in your life right now.

Fortunately our products are in demand during both boom and bust times. So if this is "recession", bring it on!

Navinder Narang wrote:
Well, the best indicator to those who have been laid off would be getting equally good jobs again. Another indicator in the market would be decreasing nervousness and reducing discounts on sales.

Duane Jones wrote:
When the "Media" shuts its mouth and stops telling everyone how bad they think it is. This has been a "Media" caused meltdown that thas spiraled out of control. As long as uninformed people keep hearing negative information and react accordingly and then repropagate negative info to more ignorant people who react accordingly......and so on, and so on, etc. It's a downward spiral that has led to "no-condidence" by the masses. Everyone needs a dose of optimism. God inspired-Christ centered OPTIMISM. I'm OK because GOD is in control. Halaluya, Amen. NOW GO OUT AND GET YOUR GRANDE, NON-FAT, WHITE CHOCOLATE MOCHA.

Windy May Martin wrote:
When I can afford my grande, non-fat white chocolate mocha again :)

Cory Drescher wrote:
There is a simple and complex answer and I apologize in advance If someone has already stated either. They both play into one another also. I'll present to you two problems and the only solution or trigger that I see.

Cause: The baby boomers combining with Generation (X's ers) by having their children and (quantity) more of them at an older age.
Effect: Obvious Social Security (Bust/reform) call it what you will and "no pay to play" scenario. No pay to play; meaning the new generation is not multiplying sexually at a fast enough rate or working at enough jobs and or making enough money to support the generations that preceded them.

Cause: Outsourcing of Business Activities by nearly all companies to save cost and to offer better service to their customers.
Effect: Company CEO's make more money, middle management is first to go along with the middle class. Example: the service logistically that UPS provides is top notch and cheaper than most companies can do it for themselves.

ONLY solution: It is not the new generation fault it can not support the old or anyone's for that matter. We will continue to evolve as we have shown all through history. The Signal will be when the entire world, or at least a few as seen in the past, trigger many to take control of their own future. Example: start your own company in a field that has life to support you in the down turn economy. Can't get the money some may say. Don't have the money some may say. Fine sell someone else product that is still selling well today. What ever you do, do not pay for anything to sell their product. Get commission only or base plus commission. How do you find such things. Visit your local University that has an active center for entrepreneurship and ASK! Action will save this economy we just have to change ourselves.

Hale Stewart wrote:
That's an incredibly big questions. From a purely mechanical perspective, here is a list of economic indicators that are considered leading indicators:

Average weekly hours, manufacturing
Average weekly initial claims for unemployment insurance
Manufacturers’ new orders, consumer goods and materials
Vendor performance, slower deliveries diffusion index
Manufacturers’ new orders, nondefense capital goods
Building permits, new private housing units
Stock prices, 500 common stocks
Money supply, M2
Interest rate spread, 10-year Treasury bonds less federal funds
Index of consumer expectations

There are several important categories.

Manufacturing: when people start buying things it means manufacturers start to produce more "stuff". Therefore, look for anything that indicates manufacturers are making more "stuff".

When the economy is picking up, people start to invest in real estate. That means building permits increase.

Stocks are considered a lead indicator as well.

I should add that I write about the economy regularly on my blog:

Deepak Kumar wrote:
While there are many ways to look at this, the stock market generally leads the real economy by a few months

i'd say dow at about 25-30% gain from here would be a good indicator

Rick C wrote:
If I had to sum it up in one word "accountability"...
I'll leave it at that, I don't want to piss off any people in the banking industry until after I get my loan ...hehe

Bo Varga wrote:
In US the upturn has to be driven by increase in employment, so three months of increasing employment would at least signal the bottom. Also a strong test of the Dow at 6,000 would signal a major, long term buying opportunity for patient capital. Per the comment from Mr. Porcano the economy is not one bundle but many threads. For example our high tech consulting business is up this year from last year and last year was better than 2007.

Pradyot Sahu wrote:
>It is always sunny someplace, so if you are looking for sun there is no need to >wait, just go to where the sun is already shining.

Good thoughts Leonard !

Leonard Porcano wrote:
I think we often think of the economy as being mechanical, where it is either moving in one direction or another. The problem is that it is not really mechanical at all. When you look at economic cycles, it is almost never the same businesses which lead you out of a recession, as lead you into one. There are some businesses which are already growing. It is these businesses that are already growing which will fuel the next expansion. At the same time, you still have contraction going on in other areas, so the economy as a whole may still be contracting even as it is growing.

The business media is somewhat obsessed with identifying a point where the economy turns, they want to turn an organism like the economy into a line on a chart. The problem with this mentality is that a line on a chart can not possibly represent the complexity of an organism like the economy. I don't believe that focusing on this point or the other is helpful. Instead look at the areas that are already growing, and put your attention there.

It is always sunny someplace, so if you are looking for sun there is no need to wait, just go to where the sun is already shining.

Fabio Bernardes wrote:
Maybe the continuity in retail sales (consumer & package goods) for more 3 months would a be a good indicator and so, the companies may start to release their B2B projects.

Bruce Bartlett wrote:
A rise in interest rates. An increase above their present anemic level would indicate firming markets, but at the same time a slight rise would place us at a still historic low showing improvement, but still not back to norms.

Abhishek Srivastava wrote:
I think core sectors growth numbers can indicate that, so in indian context, IIP numbers are a sign. This number has been showing weakness for the last few quarters. Second factor to look for is bond yield numbers. It is important for the banks to raise money at low cost and accordingly make it available at low cost to the corporates/business which allows industries to expand. So we should also look at Givt bond rates and Corporate Bind rates, it is in the same order that indicates softening.

Finally, the consumer spending numbers, look at the quarter financial numbers of retail chains like Big Bazaar, which is a real indicator of indian middle class's spending.

Atul Jain wrote:
In economist terms, there could be many. In common man terms, here are few -
1. No fear of job-loss for people who are working
2. No further Job loss news in news papers
3. Companies start hiring and people start getting jobs that they deserve
4. Stock market moving up every week for at least 1 month - at least 5% per week
5. People stop posting blogs on downturn or recession
6. No unexpected SALE in malls and shops
.... and many more