Farmers & Merchants Bank

Digging into the Leading Economic Indicators

The Leading Economic Index (LEI) was down 0.7% versus the prior month. It was the fourteenth consecutive monthly decline. The aggregate index is 9.4% off its high and drops of this magnitude are always associated with recession. Therefore, many conclude equities are a dangerous place to be. They may be forgetting that equities are the king of leading indicators.

LEI drops 10-12%

•   In August of 2001, the LEI was down about 9%. The S&P 500 had a drawdown of 20-25%. Then September 11 happened, which was a shock to a fragile economy.
•   In December of 1988, the LEI peaked only to see the S&P 500 race 40% higher. There would be a 20% pullback in 1990 as the series troughed, but equities were never below their 1988 level.
•   In 1978 the LEI would drop 13% in the first of the double-dip recessions. Despite this, the S&P 500 was up 30%, which included a six-week 20% drawdown in March 1980.
•   The 1982 recession, the second in short order, saw the LEI down 9% at its low point. The S&P 500 drawdown was about 20%. It would surge 66% over the following year.
•   If you combine 1978-1982, the LEI fell 17% in aggregate, yet the S&P 500 was up 58%. This is likely due to real returns of -50% over an eight-year period and extreme negative sentiment. Neither of these are in play today.

LEI drops more than 15%

•   The recession of 1974 saw the S&P 500 drop 25% by the time the LEI was down 9%. The total drawdown was about 40%.
•   In March 2008, the LEI was down 9% from its peak. The S&P 500 was up about 6% from when the series peaked in 2006 but was down about 18% from its high.
•   While the market didn’t foresee the financial crisis in 2008 until later, by the time the LEI was down 9% in both 1974 and 2008, the S&P 500 was near a 52-week low.
•   This cycle, the S&P 500 had a 20-25% drawdown but is now 25% above its 52-week low. Despite the media saying that no recession is priced in, the market likely already priced in a recession with the drawdown in 2022. Equities and the LEI are more aligned than one would initially think. It is certainly reasonable that some or maybe all of the 25% rally is prone to pullback as the recession becomes clear. But unless the LEI falls 15% or more, i.e. major recession, the market bottom set in 2022 has a good chance of holding.