Leading Economic Index and the Stock Market
Posted in Economic Indicators
July 29, 2009
The Conference Board publishes “leading, coincident, and lagging indexes designed to signal peaks and troughs in the business cycle for nine countries around the world,” including the widely cited Leading Economic Index (LEI) for the U.S. Does the LEI predict stock market behavior? Using the as-released monthly change in LEI from archived Conference Board press releases and contemporaneous S&P 500 Index data for June 2002 through June 2009 (85 monthly observations), we find that:
The Conference Board releases the LEI for a month about three weeks after the end of the month. To analyze its relationship to the stock market, we consider market behavior relative to both the month measured by LEI and the LEI release date. Also, since the Conference Board regularly recalibrates the level of LEI, we focus exclusively on the monthly change in LEI.
The following scatter plot relates the monthly change in the S&P 500 Index to the monthly change in LEI for the same calendar month over the entire sample period. The average monthly change in LEI is 0.03%, and the average monthly change in the S&P 500 Index is -0.07% over this period. The Pearson correlation between the two series is 0.37, and the R-squared statistic is 0.14, implying that monthly variations in LEI explain 14% of concurrent stock market movements (or vice versa). However, as noted, the LEI reading for a calendar month is not available until well after the month has ended.
To evaluate the exploitable predictive power of LEI for stocks, we focus on LEI release dates.
The next scatter plot relates the change in LEI to the change in the S&P 500 Index from close on the day before the LEI release date to the close on the day before the next LEI release date over the entire sample period. The Pearson correlation between the two series is 0.00, and the R-squared statistic is 0.00, implying no predictive power for LEI over the month after its release.
As a separate simple ranking test, we calculate the average S&P 500 Index return during the month after LEI release when the change in LEI is positive (average stock market return -0.03%) and when the change in LEI is negative (average stock market return +0.35%) over the entire sample period. Also, average stock market returns during the month after release of the ten most positive and ten most negative changes in LEI are both negative.
Might LEI be looking ahead more than one month?
The next chart shows the Pearson correlations between monthly change in LEI and release-to-release changes in the S&P 500 Index for lead-lag relationships ranging from stocks lead LEI by six months (-6) to LEI leads stocks by six months (6). As noted above, the correlation is 0.00 for the assumption that LEI leads stocks by one month. The most reasonable interpretation of results is that LEI, when released, lags the stock market by one to two months and probably does not predict stock returns at any future interval up to six months.
What about trading in the few days around releases of new LEI data?
The final chart shows the mean daily returns for the S&P 500 Index from three trading days before to three trading days after LEI release dates over the entire sample period, with one standard deviation variability ranges. Trading day 1 is the day of release. The mean daily return for all days during the sample period (approximately July 2002 through July 2009) is 0.01%. Results indicate little or no stock market anticipation of or reaction to LEI releases.
In summary, evidence from simple tests does not support a belief that the Conference Board’s Leading Economic Index for the U.S. predicts short-term or intermediate-term behavior of the U.S. stock market.
