Leading economic indicators. Now, leading economic indicators obviously indicate potentially where the economy may be headed. And how does it do that? Well, leading economic indicators, you know, typically have turning points that usually proceed that of the overall economy. They are believed to have value for predicting the economy's future state, but usually just in the near term. Now, here in the US, we have many leading indicators. And it ranges from inventory levels, manufacturing, retail, weekly hours, housing market, expectations for the consumer and businesses and what we call the LEI. And the LEIs actually stands for the index of leading economic indicators and has 10 components. And it including all that we've discussed that run the gamut between capital goods, changes in the consumer expectations, to swings in the stock market. And that leads us to the two most widely used leading economic indicators which are the stock market and construction permits here in the US. Now, it's important to keep in mind that investment analysts and economists, in order to get a clearer as possible picture of the economy, in practice, they frequently consider several indicators all at once without just focusing on one. And why is that? Well, some indicators may be a good predictor for expansions, economic expansions, but poor predictors of recessions. And this uncertainty is why economists and analysts often combine these different indicators to try to find a common factor among them to make a intelligent forecast of the direction of the economy. Now let's take a deeper look into those two most commonly looked at leading indicators. First, the stock market. Now, many will argue that the stock market is not the most important indicator. But it's often the one that people look at first. And that's because the stock market anticipates. Stock prices are always forward-looking. And prices are set upon expectations around corporate earnings and their cash flow. And as a result, the market can indicate the economy's direction if these estimates are accurate. Of course, estimates around future earnings and cash flow aren't always accurate. Along those same lines, the stock market can indicate economic turning points, either on the upside or the downside for the overall economy. And as you may guess, a positive change in the S&P 500, for example is supposed to lead or come before an increase in aggregate economic activity or an increase in GDP. An increase in the S&P 500 would be positive for future economic growth, holding all else equal, of course. And lastly, the market tends to lead the economy by about six months or so based upon historical data. Now, here's a recent graph showing the movement of the broad equity markets as measured by the Russell 3000 versus GDP here in the US or a gross domestic product. The area shaded in gray is actually the period during the recent financial crisis. And if we take a look at peaks before the crisis, the Russell 3000 peaked in Q4 2007 about three quarters before GDP in Q3 2008.

Again, a leading indicator of where GDP was going in the near term. Now, these indications aren't always correct. If we look at 2015, we see a somewhat sharp decline in the Russell 3000 that was not followed by a decrease in economic activity or the GDP. That's why it's important not just to look at one indicator. Next, construction permits. And construction permits give us insight into the supply of real estate in the near term. And as you would expect, high levels of construction permit activity would indicate active construction, more jobs and a higher GDP in the near term. And conversely, lower levels, declining construction, less jobs and less GDP. Now, that housing market is closely linked to the overall economy, even though construction employment is still only about 4 to 5% of total employment in the US. The housing market has substantial impact, because a spillover into home improvement industries and home furnishing industries. In addition to strong housing market is a sign of consumer confidence in the near term. Now, what may be even more important than the actual permit levels is the trend in demand for permits. Now, the construction sector, not just in the US, but in many countries, tends to still be a large portion of their economies. And it tends to be a very volatile sector, actually. So falling demand in new building permits is an indicator that construction sector is going into a downturn or as peaked. And this could potentially be followed by an economic downturn or a peak in economic activity, also. And here is a similar chart to what we just saw. But instead of the stock market, we're graphing construction permits alongside GDP. Again, the gray area is the financial crisis. And you can see that permits peaked well before the economy peaked, actually about three years, and trended lower for quite some time before the peak in the economy. On the upswing, permits bottomed in Q1 of 2009, a closer indication to when GDP bottom, which was just one quarter later.