The Conference Board’s Coincident-Lagging Ratio has done a pretty good job of identifying recessions since 1958. That is, until now. In each of the last eight recessions, the Coincident-Lagging Ratio bottomed near the end of the recession and was declining throughout the recession. It has been a pretty reliable indicator giving only three false signals, excluding the recent data, in 1967, 1986, and 1996. As reminder, there are four coincident components and seven lagging components. They are listed below.
The general economic thinking is that near the end of an economic cycle lagging indicators are growing faster than coincident indicators, which leads to a decline in the ratio. As the first chart below shows, this ratio has clearly been declining since 2011, however, the US has been able to avoid a recession. While looking at just the ratio clearly tells you something what is going on in the economy, there seems to be a better way of looking at this ratio that may help explain why the US hasn’t been in a recession.
The important information value in this ratio seems to be when there are large one-year changes in the level of the ratio in either direction.. If you take the one-year difference in the ratio, you can see that it has a strong relationship to real GDP. When lagging indicators strongly outperform coincident indicators, this is a clear sign the economy is slowing down. Likewise, when coincident indicators are growing much faster than lagging indicators it is clear the economy is in an expansion phase. Even though this ratio has been declining recently, it hasn’t been falling very steeply which may help explain why the economy has avoiding falling into a recession. To us, we aren’t very concerned that this ratio is at 41-year lows. However, if this ratio continues to fall, and most importantly, if it falls dramatically than we would be on the lookout for other signs that a recession is imminent (or even already underway).
Article by by Eric Bush, CFA – Gavekal Capital Blog