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Timothy Slaper
Indiana Business Research Center

George Vlahakis
IU Communications

Last modified: Thursday, October 18, 2012

IU Kelley School's Leading Index for Indiana moved above 100, but concerns remain

Oct. 19, 2012

BLOOMINGTON, Ind. -- The Leading Index for Indiana hit a major threshold, moving up from a revised reading of 99.8 in September to 100.1 in October.

Not all of the LII's components were in sync, however. The Purchasing Manager's Index moved up into the economic expansion zone, and home builders' sentiments also gave the index a boost. On the other hand, the Dow Jones Transportation Average moved down by 2.3 percent, even while the rest of the stock market moved up in September, when the S&P 500 moved up 2.4 percent.

"This disconnect in the two stock market indexes is representative of broader economic forces," said Timothy Slaper, director of economic analysis at the Indiana Business Research Center in Indiana University's Kelley School of Business, which compiles the monthly report.

"Consumer confidence has been rising lately. The Thomson Reuters/University of Michigan's October Consumer Sentiment Index rose from 78.1 points last month to 83.1 points in October," Slaper said. "Even while consumers may feel more optimistic about their future, businesses -- small businesses especially -- are more pessimistic."

The National Federation of Independent Business Small Business Optimism Index lost ground in September. The recession-level reading was pulled down by a deterioration in labor market indicators, with job creation plans plunging 6 points, job openings falling 1 point and more firms reporting decreases in employment than those reporting increases in employment.

The sentiment of small businesses is corroborated by the Conference Board Measure of CEO Confidence, which fell in the second quarter and declined again in the third quarter. It now reads 42, down from 47 in the previous quarter (a reading of more than 50 points reflects more positive than negative responses).

Tim Slaper

Timothy Slaper

Print-Quality Photo

"CEOs' assessment of current conditions remains weak, and they have grown increasingly pessimistic about the short-term outlook," Slaper said. "Sluggish growth and a persistent cloud of uncertainty have played a role in CEOs curtailing spending plans this year."

While businesses are concerned about the fiscal cliff, it is still an open question about the degree to which consumers are considering its devastating potential economics effects. If the economy falls off the cliff, the economy is expected to shrink by about 0.5 percent in the first two quarters of 2013, according to the Center for Econometric Model Research at IU.

Even if the fiscal cliff is averted, economic growth for 2013 would be about 2.2 percent, insufficient to put a real dent in unemployment.

Speaking of unemployment, the rate fell below 8 percent. "On the surface, this is relatively good news regarding improving economic conditions, but there is a hitch. The number of jobs created in September was disappointing, not enough to make up for population growth," Slaper said.

"It is likely that the drop in the unemployment rate was due to a statistical aberration," he said. "The unemployment rate is based on a survey of households while the number of new jobs is based on a survey of organizations that actually do the hiring. The two measures and two survey results move in tandem over the long run but can deviate significantly month to month."

Other moderately good economic news includes a solid September retail sales report, fueled in large part by electronic sales ("Think iPhones," Slaper said) and auto sales of 14.9 million units on a seasonally adjusted annual rate.

"That said, the higher retail sales figures were also a result of elevated gasoline prices," Slaper added. "Gasoline prices are on track to register an all-time-high annual average."

In summary, consumers are spending more and their confidence is rising. On the other hand, businesses are investing less and their confidence is slipping. The difference probably has something to do with the calculation of the impact of the fiscal cliff. Consumers are responding to stability in home prices and the pickup in equity prices. Businesses remain focused on the potential for a policy mistake coming out of Washington.

Drivers of Change

Many home builders are reporting increases in the number of serious buyers visiting their sales offices; their overall confidence increased yet again, but by a more modest 1 point this month. The National Association of Home Builders' Housing Market Index moved from 40 in August to 41 in October. The gains were shared across three of four regions, with the Midwest increasing 2 points from last month.

"Despite the gains in confidence, there is still concern that, even though demand for new homes is rising, overly tight credit conditions are still constraining new building and new purchases at a time when that kind of economic activity and the job growth it generates are greatly needed," Slaper said. "One might note that while confidence has improved, the HMI is an index for which a reading of 50 indicates that an equal number of builders view future sales conditions as good versus poor. Thus, home builders are not wildly sanguine, but as a group they are less pessimistic about future prospects."

The Institute for Supply Management's Purchasing Managers Index moved out of the "economic contraction" zone in September, increasing from 49.6 to 51.5, putting positive pressure on the LII. Among the components of the PMI that registered increases from September to October were new orders -- up from 47.1 to 52.3 -- and employment -- up from 51.6 to 54.7. A PMI reading above 50 signals expanding economic activity in the manufacturing sector.

September auto sales were better than in August, almost hitting the psychological threshold of 15 million units. September's sales were almost 13 percent higher than the same month last year. Unfilled orders for motor vehicle bodies, parts and trailers -- the auto sector component for the LII -- has not seen similar increases however, seemingly content to remain flat over the summer. Thus, changes in this indicator have had no perceptible effect on the LII.

The transportation and logistics component of the LII -- the Dow Jones Transportation Average -- continued to drift down in September, dropping an additional 2.3 percent and putting downward pressure on the LII.

"The behavior of the Dow Jones Transportation Average relative to the broader market is something of a mystery," Slaper said. "Transportation and logistics companies make their money moving goods and people, but, based on the direction of the average, analysts and investors in these stocks must think that future prospects for moving goods and people are dimmer."

This is in contrast to the stock market as a whole, which based on recent increases must have a more positive view of the future. The August waste economic index -- a measure that tracks the amount of waste and scrap hauled by railroads and that tracks with current economic output -- was 11.3 percent lower compared to last year. This may help explain why the transportation stocks portend a slowdown in economic growth.

The Federal Reserve announced in September it saw no end in sight to QE3, also known as quantitative easing. The targeted liquidity is intended to help the residential real estate market by reducing the cost of mortgages.

"The degree to which this policy will help those who are truly underwater remains to be seen," Slaper observed. "As stated before, the interest rate spread component of the LII is really a story about the behavior of the 10-year Treasury interest rate, given that the Federal Funds rate hovers near zero as part of stated Fed policy."

The rate on 10-year Treasuries dropped again in September.

About the Leading Index for Indiana
The LII, developed by the Indiana Business Research Center, is designed to reflect the unique structure of the Indiana economy. It is a predictive tool that signals changes in the direction of the economy several months before the economy has changed. In contrast to economic forecasts, which use sophisticated statistical models to foretell particular levels for a wide variety of economic activities and outcomes in the future, a leading index is a simple construct that indicates a general direction of future economic activity expected in the next five to six months.