May 30 2007 1:01PM | Permalink | Email this | Comments (0) |
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Our favorite leading indicator anticipated both the weakness in the economy around the end of the year and the recent improvement in most readings of economic activity and now suggests continuing strengthening of economic activity for the rest of this year. In turn, this suggests that new home construction will not worsen from recent reports and nonresidential construction activity will continue to strengthen.

The leading indicator is a composite of short term credit rates, housing starts and equity indexes which typically leads economic activity by about five months. The leading indicator has been depressed for the last two and a half years as economic growth stepped down from over 5% to near 1%.

The absolute low reading for the indicator was in mid-2005, about half a year before the collapse of the housing market pushed economic growth below the long-term trend for the first time in several years. Then the leading indicator trended up at a minimal pace through last August when it began to rise more quickly. The 1st quarter slump in GDP growth followed a year of little change in the indicator at a depressed level. The recent pickup in consumer and business spending followed two quarters after the indicator began to rise more quickly. Note in the accompanying chart that the recent improvement in the leading indicator is very modest compared to the surge that set off the recovery from the last recession earlier in this decade.

Our preliminary May estimate for the leading indicator is that it is approaching a 1.0 value which suggests a return to the long-term GDP growth trend of 3.0% plus by the end of the year. This GDP growth rate is the Reed Construction Data forecast as well as the consensus of most economic forecasts.