Transcript Asia Pacific Economic Dialogue Session 1

U.S. and Global Indicators Program
Using a Composite Index of Financial Conditions
Indicators to Predict Turning Points in the U.S. Business
Cycle
COPAFS Quarterly Meeting -- September 9, 2011
(Work in progress please do not cite without permission)
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Overview
 What is The Conference Board and what does it do?
 Economic indicator programs
 Business cycle programs: LEI and CEI
 LEI and financial indicators
 Concluding comments and questions
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What is The Conference Board?
 Global independent business membership and research
organization
 Provides the world's leading organizations with the practical
knowledge they need to improve their performance and better
serve society
 Founded 1916
 Non-advocacy, not-for-profit
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What Does The Conference Board Do?
 Research and education
 Conferences
 Councils
 Research reports and executive action memos
 Periodicals
 Briefings
 Data products
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Economic Indicators
 Long tradition of economic measurement work
 Wide-range of indicators
 Help-wanted and now Help-wanted Online
 Consumer confidence
 U.S. and Global composite coincident and leading indexes
 Productivity and per capita income levels and growth rates globally
 Business confidence
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Business Cycle Indicators Program
 Transfer from BEA 1996
 Advisory board
 Evaluation and updating composite indicators, 1996
 “Real” time analytic and production goals
 Introduction of statistical imputation in 2001
 Introduction of indexes for other countries
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Indicator Approach to Business Cycles
 Recessions versus slowdowns
 Monthly frequency
 Use of composite indexes
 Coincident index provides gauge of “current
conditions”
 Key to developing new indexes
 Determining turning points
 Leading index anticipates peaks and troughs
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Construction of Indexes
 Seasonal adjustments
 Deflation
 Volatility adjustments
 Equal weights
 “Real time”
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Global Indicators
 Introduced indexes for ten new countries
 Australia, China, Euro Area, France, Germany, Japan,
Mexico, South Korea, Spain, United Kingdom
 Consistent methodology
 A note on dating business cycles
 Asian Economic Symposium in Singapore in 2005
 Hosted 30th bi-annual CIRET Conference in New York in
2010
 Euro Area LEI in 2009
 China Center and LEI for China in 2010
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LEI Review
 Last comprehensive review of components was in 1996
 Introduced the interest rate spread component (10 year Treasury
bonds less Federal Funds rate)
 Omitted sensitive materials prices
 Omitted unfilled orders for durable goods
 Manf. New orders, nondefense cap goods, replaced contracts and
orders for plant and equipment
 Change in deflator for some real series (pce deflator)
 2001 TCB introduced more timely LEI, pulling release schedule up by
two weeks
 2005 TCB (re-)introduced trend adjustment and a new calculation
method for contribution of interest rate spread component
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Composition of Coincident Index
Employees on Non-Agricultural Payrolls
Index of Industrial Production
Personal Income less Transfer Payments
Manufacturing and Trade Sales
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U.S. Business Cycles and the Leading and Coincident
Economic Indexes
69:12
70:11
Peak: 60:4
Trough: 61:2
120
73:11
75:3
80:1 81:7
80:7 82:11
01:3
01:11
90:7
91:3
07:12
09:6
The Conference Board Leading Economic Index® for the U.S.
The Conference Board Coincident Economic Index® for the U.S.
110
100
90
80
70
60
50
40
30
Source: The Conference Board
20
1960
12
1965
1970
1975
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1980
1985
1990
1995
2000
2005
2010
Coincident Economic Index mirrors real GDP and LEI
leads both
Peak:
60:2
Trough: 61:1
140
69:4
70:4
73:4
75:1
90:3
91:1
80:1 81:3
80:3 82:4
01:1
01:4
07:4
09:2
The Conference Board Leading Economic Index® for the U.S. (left scale)
Real GDP (right scale)
130
14,000
13,000
120
12,000
110
11,000
100
10,000
90
9,000
80
8,000
70
7,000
60
6,000
50
5,000
40
4,000
30
3,000
Sources: BEA; The Conference Board
20
1960
13
1965
1970
1975
1980
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1985
1990
1995
2000
2005
2010
2,000
The Conference Board Leading Economic Index®
(LEI) for the U.S.
•
•
•
•
•
•
•
•
•
•
•
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Yield Spread (10-Year minus Federal Funds), Federal Reserve
Money Supply (M2), Federal Reserve (PCE deflator)
Stock Prices (S & P 500), Standard & Poors
Average Weekly Hours for Manufacturing, BLS
Building Permits, Private Housing, Census
Average Weekly Initial Claims for Unemployment Insurance, BLS
Vendor Performance, (manufacturing) ISM
Manufacturer’s New Orders for Non-Defense Capital Goods, deflated,
Census, BLS
Manufacturer’s New Orders for Consumer Goods and Materials, deflated,
Census, BLS
Index of Consumer Expectations, University of Michigan
Index methodology is based on equally weighted average of
standardized contributions of 10 components
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Financial/Non-financial LEI - levels
Index, 2004=100
140
130
Financial LEI
Non-financial LEI
120
110
100
90
80
70
60
50
40
30
Jul '11
20
1960
15
1965
1970
1975
1980
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1985
1990
1995
2000
2005
2010
Close up on Index Levels
Index, 2004=100
120
LEI_LESSM2
LEI_WITHM2
115
110
105
100
95
90
85
Jul '11
80
2000
16
2001
2002
2003
2004
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2005
2006
2007
2008
2009
2010
2011
6-month growth rate of M2 & CEI
Six-month percent change (annualized)
20
US CEI
M2 Money Supply
15
10
5
0
-5
-10
1960
17
1965
1970
1975
1980
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1985
1990
1995
2000
2005
2010
Areas of possible improvement in the U.S. LEI and
proposals for changes in the composition




Address structural changes in the U.S. economy and financial markets
Improve coverage of financial conditions and activity indicators
Omit real money supply component (M2)
Substitute a better indicator of financial conditions for M2
 But also other areas of improvement:
 Improve coverage of new orders
 Improve measurement and coverage of consumer
expectations of business and economic conditions
 Methodological improvement to use diffusion indexes in
levels rather than changes
 Improve measurement of current economic conditions (i.e.,
CEI)
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Deciding whether or not to include a leading indicator in the
composite index:
 The indicator is economically significant.
 The indicator measurement is statistically sound.
 The index has fewer false signals (extra cycles) historically
when a new component is included.
 The inclusion of a component enables an index to track a cycle
that might be missed otherwise.
 A significant improvement in the cyclical timing pattern, in terms
of its consistency and conformity, of the new index after the
inclusion of the new component.
 The index is smoother with better articulated turning points.
 There is an improvement in the cyclical behavior of the new
index to the cyclical behavior of aggregate economic activity
after the inclusion of the new component.
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Creating an evaluation score to assess candidate
indicators
Source: The Conference Board
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Selected components of the Financial Conditions Index
 Two-year Swap Spreads (monthly)
 Libor 3 month Less Treasury 3-month yield (monthly)
 Debit balances at margin accounts at broker dealers (PCE deflated)
DLOG (monthly)
 Senior Loan Officer C&I Loan Survey -Banks Tightening Credit to Large
& Medium Firms (quarterly)
 AAII Investor Sentiment: Bullish (%) Less Bearish (%) (monthly)
 Total Finance: Liabilities - Security Repurchases (PCE Deflated) DLOG
(quarterly)
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Financial Conditions Index leads peaks and troughs in the
TCB FCI vs. US CEI (6-month percent change annuallized)
business
cycle
6
4
2
0
-2
-4
-6
US CEI
FCI Top 6
-8
-10
-12
1990
22
1992
1994
1996
1998
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2000
2002
2004
2006
2008
2010
2012
LEI including the Financial Conditions Index
Index, 2004=100
120
110
100
Current LEI
LEI with FCI Top 6
90
80
70
60
50
40
30
May '11
20
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Real M2 remains a component until April 1990. After May 1990 the FCI replaces M2.
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History of the new and old LEI’s very similar but improved
recession signals from Depth, Diffusion, Duration (3D’s) with
new LEI
Six-month change (annualized)
20
Six-month change (annualized)
20
U.S. LEI Old Composition with FCI and not M2
6-month diffusion index <= 50 percent
Recession Signal
15
15
10
10
5
5
0
0
-5
-5
U.S. LEI
6-month diffusion index <= 50 percent
Recession Signal
-10
-10
-15
-15
-20
Jul-11
-20
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
New LEI
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Jul-11
-25
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2010
1960
1965
1970
1975
1980
1985
1990
Current LEI
1995
2000
2005
2010
Forecasting with the new LEI
 Benchmark model of CEI growth with lagged dependent variable and
lags of current LEI (all variables are detrended first)
 Alternative models replace current LEI with alternative versions
 Estimate a regression and create sequence of out of sample forecasts
 Look at relative RMSE and Diebold-Mariano statistic to evaluate
improvement due to alternative LEI
 Forecasting exercise:
 initial estimation period: 1959 – 1979
 out of sample period: 1980-2010
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Replacing M2 with the FCI improves the out of sample
forecasting ability of the LEI
Tab1
FMSE1
Old LEI
(1)
13.312
13.312
12.388
12.388
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Forecasting CEI with Alternative LEIs compared with Forecasts made with Official LEI
Initial Sample: 1959:01 to 1979:12
Out-of-sample forecast errors for 1980:01 to 2011:05
FMSE2
Relative FMSE
Composition of New LEI:
New LEI
New/Old LEI
(2)
(3)
(4)
Forecast Horizon: 1 month ahead
0.912
LEI_PC5
12.146
0.914
LEI_PC6
12.163
Forecast Horizon: 6 months ahead
0.923
LEI_PC5
11.430
0.925
LEI_PC6
11.459
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DM Statistic
p-value
(5)
(6)
2.618
2.435
0.004
0.007
1.678
1.575
0.047
0.058
Summary
 Given the growing importance and complexity of the financial sector
there is a need to review the financial indicators in the LEI
 M2 ceased to be a useful leading indicator and should be replaced
 We want to replace M2 with an index, rather than with a single
indicator, for the following reasons:
One indicator is more likely than an index to lose its predictive
ability
An aggregation of several indicators averages out the “noise”
• The aim of the financial index is predicting turning points in business
cycle and not measuring financial stress or instability
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New Approach
 A composite index as a component of the LEI
 Use quarterly components as part of the FCI (and LEI)
 Using M2 up to 1990 and FCI afterwards
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New Composition of The Conference Board
Leading Economic Index® (LEI) for the U.S.





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Addresses structural changes in the economy and financial markets
Improved coverage of financial and credit conditions and activity
Better measurement of 2007-2009 contraction
Better forecasting performance of growth in CEI
Cons:
 FCI only extends back to 1990
 FCI contains quarterly variables that have to be interpolated and
imputed
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APPENDIX
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Charts of the Selected FCI Components - I
Two-yr Swap Spreads
3-month Libor-Treasury Spread
140
3.6
3.2
120
2.8
100
80
percent
basis points
2.4
60
2.0
1.6
1.2
40
0.8
20
0.4
0
0.0
1990
31
1992
1994
1996
1998
2000
2002
2004
2006
2008
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2010
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Charts of the Selected FCI Components - II
Millions of $
Debit balances at margin accounts at broker dealers (PCE deflated)
AAII Investor Sentiment: Bullish (%) Less Bearish (%)
400,000
60
360,000
50
320,000
40
280,000
30
240,000
20
200,000
10
160,000
0
120,000
-10
80,000
-20
40,000
-30
0
-40
1990
32
1992
1994
1996
1998
2000
2002
2004
2006
2008
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2010
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Charts of the Selected FCI Components - III
Senior Loan Officer C&I Loan Survey - Banks Tightening Credit to Large & Medium Firms
Total Finance: Liabilities - Security Repurchases (PCE Deflated)
100
2,400
2,200
80
2,000
60
1,800
1,600
Billions of $
40
20
0
1,400
1,200
1,000
800
-20
600
-40
400
90
33
92
94
96
98
00
02
04
06
08
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10
90
92
94
96
98
00
02
04
06
08
10
Turning points of the LEI
Business Cycle Peaks
NLEI_PC5
Apr-60
Dec-69
Nov-73
Jan-80
Jul-81
Jul-90
Mar-01
Dec-07
Mean
Median
St. Deviation
-3
-8
-9
-15
-8
-6
-11
-21
-10.1
-8.5
5.6
NLEI_PC6
*
*
Business Cycle Troughs
NLEI_PC5
Feb-61
Nov-70
Mar-75
Jul-80
Nov-82
Mar-91
Nov-01
Jun-09
Mean
Median
St. Deviation
-11
-7
-2
-2
-10
0
-1
-3
-4.5
-2.5
4.2
*
*
NLEI_PC6
*
*
*manually selected
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-3
-8
-9
-15
-8
-4
-11
-21
-9.9
-8.5
5.9
LEI_EXM2
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-11
-7
-2
-2
-10
0
-1
-3
-4.5
-2.5
4.2
-4
-8
-9
-15
-8
-18
-14
-23
-12.4
-11.5
6.3
USLEAD
*
LEI_EXM
*
*
-3
-7
-2
-2
-10
-2
-2
-3
-3.9
-2.5
3.0
-10
-8
-9
-15
-8
-18
-11
-5
-10.5
-9.5
4.2
USLEAD
*
-3
-7
-2
-2
-10
-2
-2
-3
-3.9
-2.5
3.0
Selecting the Components of the Financial Conditions Index
TCB Financial Index Components
Indicator
Two-year Swap Spreads
Libor 3 month Less Treasury 3-month yield
Debit balances at margin accounts at broker dealers
Senior Loan Officer C&I Loan Survey Banks Tightening Credit to Large & Medium Firms
5) AAII Investor Sentiment: Bullish (%) Less Bearish (%)
6) Total Finance: Liabilities - Security Repurchases
1)
2)
3)
4)
Frequency
monthly
monthly
monthly
quarterly
Source
Datastream
ECB, Federal Reserve, Datastream
New York Stock Exchange, Haver
Federal Reserve
monthly
quarterly
American Association of Individual Investors, Haver
Federal Reserve, Bureau of Economic Analysis
The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for
the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. Only one vote per member is accepted in
each weekly voting period.
Debit balances at margin accounts at broker dealers. Series refers to aggregate debits in securities margin accounts, as well as aggregate free
credits in cash and margin accounts. Margin accounts cover stock, convertible bond, special subscription, and corporate and government bond
accounts. This is reported by NYSE member organizations (and can be found in Federal Reserve Bulletin" Table 1.36). Deflated by PCE.
Security repurchases outstanding in financial companies. Deflated by PCE. From Flow of Funds Liabilities. (Table L.5 Total Liabilities and Its
Relation to Total Financial Assets, item 11 – Security RPs.)
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