The Role of Composite Indexes in Tracking the Business Cycle

Trusted Insights for Business Worldwide The Role of Composite Indexes in Tracking the Business Cycle INTERNATIONAL SEMINAR ON EARLY WARNING AND BUSINESS CYCLE INDICATORS 14 December 29, Scheveningen, The Netherlands www.conference-board.org 1 www.conference-board.org 29 The Conference Board, Inc. Ataman Ozyildirim Associate Director, U.S. and Global Indicators Program a.ozyildirim@conference-board.org

Business cycles defined Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years; they are not divisible into shorter cycles of similar character with amplitudes approximating their own. Wesley C. Mitchell, (1927), Business Cycles: The Problem and Its Setting, New York, NY: National Bureau of Economic Research. Burns, A. F., and Mitchell, W. C. (1946), Measuring Business Cycles, New York, NY: National Bureau of Economic Research. 2 www.conference-board.org 29 The Conference Board, Inc.

Business cycles and indicators The indicator approach, one of several techniques of business cycle analysis, has been a major component of the NBER program since Burns and Mitchell (1946). The first list of leading indicators dates back to Mitchell and Burns (1938). Major revisions: Moore (195), Moore (1961), Moore and Shiskin (1967), Zarnowitz and Boschan (1975), Hertzberg and Beckman (1989), and The Conference Board (21). Also, other changes on a smaller scale occasionally (removal of a component in 1987 by The U.S. Commerce Department, re-introduction of trend adjustment in 25 by The Conference Board). 3 www.conference-board.org 29 The Conference Board, Inc.

28 recession: Most talked about least predicted Martin Wolf, Financial Times LEI for the U.S. sideways from January 26 and diffusion roughly around 5 percent Housing market and yield spread down, but money growth was keeping the LEI from falling further 6m diffusion did fall below 5 by May 27 and LEI peaked in July 27, and CEI peaked in November 27 Initially mild contractions, deepening in the second half of 28 LEI seems to have a trough in March 29 While CEI hasn t picked up yet (but a bottom seems to be forming) But, LEI growth is already losing some steam in the last couple of months as its growth rate stabilizes 4 www.conference-board.org 29 The Conference Board, Inc.

Tracking cyclical movements Wide-range of indicators Money and credit indicators Manufacturing indicators Labor market indicators Investment indicators Consumer and business confidence Composite coincident and leading index summarize and emphasize cyclical movements Looking beyond irregular and seasonal movements in data to the common and regular cyclical fluctuations 5 www.conference-board.org 29 The Conference Board, Inc.

U.S. Business Cycle Indicators Database contains more than 25 series BCI-2 - Labor Force, Employment, and Unemployment BCI-3 - Output, Production, and Capacity Utilization BCI-4 - Sales, Orders, and Deliveries BCI-5 - Fixed Capital Investment BCI-6 - Inventories and Inventory Investment BCI-7A - Prices-Producer & Consumer BCI-7B - Prices-Commodity price detail BCI-9 - Wages, Labor Costs and Productivity BCI-1 - Personal Income and Consumer Attitudes BCI-12 - Money, Credit, Interest Rates, and Stock Prices BCI-13 - National Defense BCI-14 - Exports and Imports BCI-15A - Int'l Comparisons-Industrial Production & Consumer Prices BCI-15B - Int'l Comparisons-Stock Price Indexes & Exchange Rates Composite coincident, leading, and lagging indexes combine best indicators to bring out and summarize common cyclical movements 6 www.conference-board.org 29 The Conference Board, Inc.

Deciding whether or not to include a leading indicator in the composite index: The indicator is economically significant. The indicator measurement is statistically sound. The index has fewer false signals (extra cycles) historically when a new component is included. The inclusion of a component enables an index to track a cycle that might be missed otherwise. A significant improvement in the cyclical timing pattern, in terms of its consistency and conformity, of the new index after the inclusion of the new component. The index is smoother with better articulated turning points. There is an improvement in the cyclical behavior of the new index to the cyclical behavior of aggregate economic activity after the inclusion of the new component. 7 www.conference-board.org 29 The Conference Board, Inc.

The Conference Board Economic Indexes for the U.S. 14 12 1 8 6 4-9 U S L E A D -11-4 -11-1 -15-9 -2-1 -19-2 -11-7 -5 9:3-9 196 1965 197 1975 198 1985 199 1995 2 25 21 14 12 1 8 6 4-3 U S C O IN -2 +1 +1 +1-1 -6 +4-1 2 196 1965 197 1975 198 1985 199 1995 2 25 21 12 1 8 U. S. L A G +6-3 +28 6 4 +1 +4 +15 +13 +15 +3 +2 +3 +6 +21 +6 196 1965 197 1975 198 1985 199 1995 2 25 21 Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. The numbers denote the leads in months at cyclical peaks and troughs. 8 www.conference-board.org 29 The Conference Board, Inc.

Data Needs and Timeliness Issues Historical data required for construction Seasonal adjustments and price deflators necessary Timely data required for real time monitoring Dealing with publication lags 9 www.conference-board.org 29 The Conference Board, Inc.

Business cycles are asymmetric and relatively infrequent Peak: Trough: 11 1 9 8 7 6 5 4 3 Major cyclical fluctuations of the LEI correspond to and predict business cycle turning points 6:4 61:2-9 -11-8 69:12 7:11-7 -9 U.S. Leading Economic Index 73:11 75:3-2 -15 8:1 81:7 8:7 82:11-2 -8-1 -18 9:7 91:3-2 -11 1:3 1:11-7 7:12-5 Peak: Trough: 11 1 9 8 7 6 5 4 5 recessions in 25 years 6:4 61:2 69:12 7:11-2 73:11 75:3 +1 U.S. Coincident Economic Index 8:1 81:7 8:7 82:11 +1 +1 3 recessions in 25 years 9:7 91:3 +1 1:3 1:11-3 +1 7:12-1 2 6 65 7 75 8 85 9 95 5 1 Note: Shaded areas represent recessions as determined by the National Bureau of Economic Research. The numbers denote the leads in months at cyclical peaks and troughs. 3 6 65 7 75 8 85 9 95 5 1 Note: Shaded areas represent recessions as determined by the National Bureau of Economic Research. The numbers denote the leads or lags in months at cyclical peaks and troughs. Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. 1 www.conference-board.org 29 The Conference Board, Inc.

Index 24=1 The Conference Board Coincident Economic Index (CEI) for the U.S. Peak: Trough: 12 6:4 61:2 69:12 7:11 73:11 75:3 8:1 8:7 81:7 82:11 9:7 91:3 1:3 1:11 7:12 11-1 1 9-6 +4 8-1 7 6 5-2 +1 +1 +1 4-3 3 196 1965 197 1975 198 1985 199 1995 2 25 Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. The numbers denote the leads in months at cyclical peaks and troughs. 11 www.conference-board.org 29 The Conference Board, Inc.

Index 24=1 The Conference Board Leading Economic Index (LEI) for the U.S. Peak: Trough: 12 6:4 61:2 69:12 7:11 73:11 75:3 8:1 8:7 81:7 82:11 9:7 91:3 1:3 1:11 7:12 1-11 -5 9:3 8-7 -19 6-11 -15-9 -2 4-11 -4-1 -2-1 -9-9 2 196 1965 197 1975 198 1985 199 1995 2 25 Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. The numbers denote the leads in months at cyclical peaks and troughs. 12 www.conference-board.org 29 The Conference Board, Inc.

Depth, Duration, and Diffusion (3D s) help predict recessions Peak: 6:4 69:12 73:11 8:1 81:7 Trough: 9:7 1:3 7:12 61:2 7:11 75:3 8:7 82:11 91:3 1:11 2 15 1 Housing permits and yield spread started contributing negatively to LEI in mid-6, while M2 keep rising 5-5 -1-15 US LEI 6-month percent change (AR) 6-month Diffusion below 5-2 196 1965 197 1975 198 1985 199 1995 2 25 21 Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. 13 www.conference-board.org 29 The Conference Board, Inc.

Financial and Nonfinancial subindexes help to understand the cyclical drivers Peak: 6:4 69:12 73:11 8:1 81:7 Trough: 61:2 7:11 75:3 8:7 82:11 5 U.S. Financ ial LEI (6-month annual rate) U.S. Non-financ ial LEI (6-month annual rate) 4 9:7 1:3 7:12 91:3 1:11 3 2 1-1 -2-3 -4 Jobless recovery 1995-96 growth cycle 1966-67 growth cycle 196 1965 197 1975 198 1985 199 1995 2 25 21 Note: Shaded areas represent recessions as determined by the NBER Business Cycle Dating Committee. 14 www.conference-board.org 29 The Conference Board, Inc.

Index Level (P eak=1) Comparison of LEI behavior during previous recessions 13 LE I P eak Dec. 7 LE I Trough* 12 21 C urrent (27) 11 A verage of previous declines 1 99 98 97 96 95 94 93 92-24 -21-18 -15-12 -9-6 -3 3 6 9 12 15 18 21 24 27 *LEI Trough refers to trough in Average of Previous Declines 15 www.conference-board.org 29 The Conference Board, Inc.

Index, 1996 = 1 U.S. LEI in real time: January 27 December 27 139 Jul. '7 138.5 138 Aug '7 Sep. '7 137.5 137 Oct. '7 136.5 Nov. '7 136 Dec. '7 135.5 135 134.5 Jan-7 Feb-7 Mar-7 Apr-7 May-7 Jun-7 Jul-7 Aug-7 Sep-7 Oct-7 Nov-7 Dec-7 16 www.conference-board.org 29 The Conference Board, Inc.

Coincident Economic Indexes suggest world economy is currently passing through the trough 2 15 1 6-month percent change (annual rate) The Conference Board Coincident Economic Index (CEI) for the U.S. (Oct '9) The Conference Board Coincident Economic Index (CEI) for Euro Area (Oct '9) The Conference Board Coincident Economic Index (CEI) for Japan The Conference Board Experimental Coincident Economic Index (CEI) for China The Conference Board Coincident Economic Index (CEI) for South Korea 5-5 -1-15 -2 6 7 8 9 Sep '9 17 www.conference-board.org 29 The Conference Board, Inc.

5 4 3 LEI for the U.S., Euro Area, Japan, China, and Korea all show improvement since March 9 6-month perc ent c hange (annual rate) T he Conference Board Leading Economic Index (LEI) for the U.S. (O ct '9) T he Conference Board Leading Economic Index (LEI) for Euro Area (O ct '9) T he Conference Board Leading Economic Index (LEI) for Japan T he Conference Board Experimental Leading Economic Index (LEI) for China T he Conference Board Leading Economic Index (LEI) for South Korea 2 1-1 -2-3 -4-5 U.S.: bottomed in 9/3, but losing some steam as growth rate stabilizes China: credit expansion and inventory rebuilding rate slow, but consumption and investment remain robust Korea and Japan: exports rebounded strongly and corporate profits improved, but conditions remain fragile Euro Area: regained some ground since 9/3, but still far below its most recent peak 6 7 8 9 Sep '9 18 www.conference-board.org 29 The Conference Board, Inc.

LEI and CEI for France, Germany, Spain, and UK 115 11 15 France LEI F r anc e C E I 8:2 112 18 G ermany LEI G er many C E I 8:2 1 14 95 9 1 85 96 8 92 75 88 7 65 84 6 8 55 7 75 8 85 9 95 5 1 76 65 7 75 8 85 9 95 5 1 12 11 S pain LE I S pain C E I 8:2 15 1 U K LE I U K C E I 8:5 1 95 9 9 85 8 8 7 75 7 6 65 5 84 86 88 9 92 94 96 98 2 4 6 8 6 7 75 8 85 9 95 5 1 Note: Shaded areas represent business cycle recessions determined by CEI and GDP. 19 www.conference-board.org 29 The Conference Board, Inc.

LEI and CEI for Australia, Japan, Korea, and China (experimental) 12 11 1 Australia LEI Australia C EI 12 11 Japan LEI J apan C E I 8:1 9 1 8 9 7 6 8 5 7 4 6 3 6 65 7 75 8 85 9 95 5 1 14 12 S outh K or ea LE I South Korea C EI 8:4 9:1 5 65 7 75 8 85 9 95 5 1 2 Chin a E x p e r im e n ta l L E I Chin a E x p e r im e n ta l C E I 8:2 9:1 1 8 6 1 8 7 6 5 4 4 3 2 2 7 75 8 85 9 95 5 1 1 86 88 9 92 94 96 98 2 4 6 8 Note: Shaded areas represent business cycle recessions determined by CEI and GDP. For China, shaded areas represent growth cycles of China s CEI. Sources: The Conference Board 2 www.conference-board.org 29 The Conference Board, Inc.

LEI and CEI for the Euro Area before and during the recession 12 115 Euro Area LEI Euro Area C EI 8 : 2 11 15-8 -1 1 95 9-19 -12 9 : 3 85 +7 8 75 +1 7 88 9 92 94 96 98 2 4 6 8 Note: Shaded areas represent business cycle recessions of Euro Area, determined by CEI and GDP. 21 www.conference-board.org 29 The Conference Board, Inc.

Depth, Duration, and Diffusion (3D s) help predict recessions in Euro Area 8 : 2 25 Euro Area LEI (6ar) 6-month diffusion below 5 2 15 1 5-5 -1-15 -2 88 9 92 94 96 98 2 4 6 8 Note: Shaded areas represent business cycle recessions of Euro Area, determined by CEI and GDP. 22 www.conference-board.org 29 The Conference Board, Inc.

Index (24=1) Trend of China Experimental CEI Growth 2 18 16 P eak: 88:8 Trough: 89:12 M odified C E I for C hina Trend of m odified C E I for C hina 14 12 1 8 6 4 2 86 87 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 Note: Shaded area represents China s economic recession using CEI, and the turning points are determined by the Bry-Boschan algorithm. 23 www.conference-board.org 29 The Conference Board, Inc.

2 /8 8 1 2 /8 9 2 /9 3 1 1 /9 3 1 2 /9 5 2 /9 8 1 / 5 / 3 3 / 6 1 / 7 3 / 8 2 / 9 Growth Cycles in the China Experimental CEI 12 1 8 6 4 2-2 -4-6 -8-1 -12 86 87 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 Note: Shaded areas represent growth cycles of China s CEI, and the turning points are determined by the Bry-Boschan algorithm. 24 www.conference-board.org 29 The Conference Board, Inc.

Economic indicators for tracking cyclical movements Business cycles in the aggregate economic activity sequence of changes is recurrent but not periodic vary from more than one year to ten or twelve years not divisible into shorter cycles Composite indexes help define, emphasize, and predict cyclical movements. Producers of cyclical indicators must be sensitive to the effects of real changes in the economy s structure, institutions, and policies. Thus, new series have been added when accumulating evidence suggested strong cyclical performance ahead of recessions. 25 www.conference-board.org 29 The Conference Board, Inc.

Business Cycle Chronologies for European Countries Leading Economic Indexes (LEI) Turning Points (all countries) Timing at Business Cycle Peaks 196's Mar-66-1 197's Aug-74-16 Mar-73-2 Jun-73-4 Nov-79-6 198's Feb-8 Mar-8-11 Oct-82-32 199's Feb-92-19 Jan-92-16 Feb-92-9 Feb-92-24 Mar-9-2 May-95-3 2's Jan-1-9 Feb-8-8 Feb-8-5 Feb-8 Feb-8-7 May-8-11 Mean -14-14 -5-8 -1 Median -14-16 -5-7 -9 St. Deviation 8 12 6 8 7 Extra Turns 3 2 1 2 4 Missed Turns Number of Cycles 2 5 2 7 4 Timing at Business Cycle Troughs 196's Feb-67 197's May-75-2 Jan-75 May-75-5 198's Aug-81-8 Nov-82 Feb-82-13 Jan-85 NA 199's Jun-93 1 Nov-93-5 May-93-7 Jul-93-2 Jan-93-18 Feb-96-4 2's Aug-3 Mar-9 Mar-9 Mar-9 Mar-9 Mar-9 Mean 1-5 -7-1 -12 Median 1-5 -7-13 St. Deviation NA 3 NA 2 7 Extra Turns 4 4 2 3 5 Missed Turns 1 Number of Cycles 1 4 1 6 3 Combined Statistics Mean -9-11 -5-5 -11 Median -8-7 -7-2 -11 St. Deviation 1 11 5 7 6 Europe Euro Area France Spain Germany United Kingdom Leading Index Leading Index Leading Index Leading Index Leading Index 26 www.conference-board.org 29 The Conference Board, Inc.

Business Cycle Chronologies for Asia Pacific Countries Leading Economic Indexes (LEI) Turning Points (all countries) Timing at Business Cycle Peaks 196's Dec-6 NA Asia-Pacific Australia Japan Korea China* Leading Index Leading Index Leading Index Leading Index 197's Mar-74-7 Feb-73 2 Oct-79-17 198's Jan-82-7 Aug-88-7 199's May-9-12 Feb-92-26 Aug-97-15 Mar-97-4 2's Dec- -1 Aug-8 Jan-8-19 Apr-8-6 Oct-7 Mean -9-1 -13-7 Median -7-4 -15-7 St. Deviation 3 12 6 NA Extra Turns 5 5 5 1 Missed Turns 1 Number of Cycles 4 5 3 1 Timing at Business Cycle Troughs 196's Sep-61-5 197's Mar-75-4 Apr-75 1 198's May-83-4 May-8 1 Dec-89-13 199's Jul-91-5 Feb-94-14 Jul-98-2 Feb-99-4 2's Jan-2-2 Jan-9 Feb-9 Jan-9 Nov-8 Mean -5-5 -1-13 Median -5-3 -1-13 St. Deviation 1 7 2 NA Extra Turns 6 5 6 1 Missed Turns Number of Cycles 4 4 3 1 Combined Statistics Mean -6-7 -8-1 Median -5-4 -6-7 St. Deviation 3 1 8 4 * China s business cycle is determined by turning points in CEI 27 www.conference-board.org 29 The Conference Board, Inc.