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Leading indicators are warning signs of future events that help change and improve future outcomes. The Leading Indicator Index is calculated based on ten variables and historically declines before a recession, but it is not always accurate. Regardless, leading indicators are useful for giving early warning of impending problems.
Indicators are a way to measure performance. They are important in many aspects of our lives. They provide feedback on what’s happening, how we can improve, and alert us to impending changes we need to prepare for.
A leading indicator is simply a warning sign of future events.
We all use leading indicators in our daily lives. A good example is the dashboard of a car. It has several gauges that alert you to a problem before it happens so you can take action and avoid car trouble, running out of gas, etc. A traffic light is another example of a leading indicator. The light turns yellow – a warning sign – before turning red, urging you to stop.
The primary role of leading indicators is to help change and improve future outcomes. In the economic arena, where the term is most commonly used, leading indicators change before the economy changes. They are early warning signs, telling us to proceed with caution.
In 1995, the Department of Commerce’s Bureau of Economic Analysis created a private non-governmental organization, the Conference Board, to determine a leading monthly index. The index, called the Leading Indicator Index, is calculated based on ten different variables. Key indicators used to calculate the index include things like the level of the S&P 500 index, the inflation-adjusted value of the money supply, and the average number of new jobless claims filed in the previous month.
There are many factors in the manufacturing industry that are taken into account when calculating the Leading Indicators Index. The number of new orders for the manufacture of goods and materials, as well as the speed with which suppliers deliver the new goods, are considered. Also included in the equation are the average weekly hours that manufacturing workers work. Last, but certainly not least, consumer sentiment and the amount of new residential building permits are considered.
Historically, these ten variables have declined before a recession. However, no system used to predict the future is perfect. One problem with the leading index index is that the delay between the signal of a possible recession and the actual recession fluctuates. The index also fell occasionally without being followed by a recession.
Regardless of their accuracy, leading indicators are useful because they give early warning of impending problems. It’s an indication that we need to take a closer look, examine what’s going on, assess the accuracy of the information, and make necessary adjustments for the future.
Asset Smart.
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