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Timothy Slaper
Indiana Business Research Center

George Vlahakis
IU Communications

Last modified: Thursday, March 21, 2013

IU Kelley School's Leading Index for Indiana points to concerns about small businesses hiring

Auto sector a bright spot; report includes special warning related to eurozone crisis

March 21, 2013

BLOOMINGTON, Ind. -- The Leading Index for Indiana continued its slow creep upward in March with a 0.1 increase from February's revised level of 100.8.

The components of the LII, like the forces of the U.S. economy, are pulling in opposite directions. Home builder confidence took a hit, but the Institute of Supply Management's measure of industrial activity and the transportation index posted gains.

"In terms of the national economy, the private sector is in fairly good shape as households have continued to rebuild their balance sheets. Larger businesses are enjoying strong profits, strong balance sheets and ample liquidity. That said, main street businesses are still in the doldrums," said Timothy Slaper, director of economic analysis at the Indiana Business Research Center in Indiana University's Kelley School of Business, which produces the economic index.

"Three-quarters of small business owners think that business conditions will be the same or worse in six months. On the plus side, the NFIB Small Business Optimism Index increased 1.9 points, but is still in the negative zone," Slaper added. "Until owners' forecast for the economy improves substantially, there will be little boost to hiring and spending from the small business half of the economy."

The Thomson Reuters/University of Michigan Consumer Sentiment preliminary number for March came in at 71.8, a notable drop from February's final reading of 77.6. If this drop reflects the fall in take-home pay as a result of the end of the payroll tax holiday, or if it reflects rising gas prices, there may be trouble ahead, Slaper noted.

"Consumer spending appears to have softened a bit at the lower end of the income spectrum, which is where the bite from tax increases and higher gasoline prices are most acute," he said. "On the other hand, spending seems to be holding up at the upper end of the income scale, benefiting from rising stock prices and the rebound in home prices."

Probably the brightest spot for the Indiana economy is the nearly booming auto sector. According to CNW Research, March sales are on track to hit 15.7 million units (seasonally adjusted annual rate) as early month floor traffic is up 2.8 percent. Many industry analysts' estimates for total sales in 2013 are north of 15.5 million units.

Chilling winds from a warm and sunny place

"Small" events can make indicators like the LII or the national leading index virtually meaningless.

"When a tiny country like Cyprus, with a GDP lower than Vermont, can roil international financial markets, you know the global economy is still in fragile health," Slaper said.

He warned that the eurozone policy decision has ramifications far beyond the island country of Cyprus.

"Thanks to a eurozone policy decision, Cyprian depositors think that there is risk to their savings and they rush to banks to pull their money out. No bank has enough cash on hand to pay off all its depositors at once and, as a result, these runs cause the banks to go belly up," he observed. "That's why the U.S. and European governments have been frantically bailing out banks ever since the fall of Lehman Brothers in September 2008.

"But thanks to the eurozone's bizarre decision in Cyprus, whether the banks fail or not, depositors in Cyprus banks will lose some of their money. Will other depositors at weak banks all over Europe -- places like Spain, Italy and Greece -- think that they will be next and pull their money out of those banks?

"That would lead to a good old-fashioned Great Depression-style European financial crisis," he added. "Is the eurozone ready, or does it have the capacity, to bail out all of Europe's weak banks at once? Most likely, the U.S. would have to get involved."

Even if the U.S. doesn't embroil itself in the tracheal intubation of eurozone financial markets, the already weak European economy would suffer massive hemorrhaging. The effects would not go unnoticed with Europe's trading partners, leading to a potential threat to U.S. exports.

Drivers of change

The National Association of Home Builders/Wells Fargo Housing Market Index that measures builder confidence in the market for newly built, single-family homes "paused" for a third consecutive month in March, with a two-point reduction to 44.

"Builders are reporting increased demand for new homes in their markets, but their enthusiasm is being tempered by frustrating bottlenecks in the supply chain with rising costs for building materials and labor," Slaper said. "At the same time, problems with appraisals and credit availability remain considerable obstacles to completing deals."

Economic activity in the manufacturing sector expanded in February for the third consecutive month, according to the nation's supply executives surveyed in the latest Institute for Supply Management's Purchasing Managers Index that registered 54.2 percent. The PMI increased 1.1 percentage points from January's reading.

"This month's reading reflects the highest PMI since June 2011," Slaper said. "As was the case last month, all five of the component indexes -- new orders, production, employment, supplier deliveries and inventories -- registered in positive territory. In addition, the backlog of orders, exports and imports indexes all grew."

February's auto sales came in at a healthy 15.3 million (seasonally adjusted annual rate), an improvement of more than 8 percent from last year.

While this news appears good, these sales gains came at a cost. According to CNW Research, manufacturer incentive levels jumped by 15.5 percent over February 2012. So while sales may be on track for 15.7 million units, this growth may come on the backs of incentives (and manufacturer profits).

The sales picture was good, but the auto component in the LII -- unfilled orders for motor vehicle bodies, parts and trailers -- fell a smidge (0.4 percent).

The transportation and logistics component of the LII -- the Dow Jones Transportation Average -- helped to give the LII some lift, rising 3.2 percent in February.

The current Fed policy of quantitative easing has undercut the interest rate spread as a good indicator of the future direction of the national economy. As a result, the strength of the change in the measure does not provide a signal of the direction or strength of future economic activity in the state.

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.