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.

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