Sat, Feb 23, 2002 page19

• US seems to be slowly emerging out of its economic slowdown

  Though analysts dismiss the indicators as 'too flaky,' there's plenty of evidence to suggest that the US economy is gradually getting stronger

  • By Caroline Baum / BLOOMBERG
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  It's funny how the world works, with a natural order guiding things large and small. You put your socks on before your shoes, shower before you dress, turn the ignition before putting the car in drive.

  So it is with things economic as well. First comes an early sign of life from financial indicators -- things like the slope of the yield curve and the money supply. They're the kind of leading indicators most analysts dismiss as too flaky to hang their hat on, which is why most of them show up at the party hat in hand -- and late.

  Call these intangible indicators what you will, they work.

  

  A shopper reaches for a package of breakfast sausages at the Wal-Mart Supercenter in Plano, Illinois, on Tuesday.

  PHOTO: BLOOMBERG

  What's more, they lead.

  The slope of the yield curve, or the spread between short- and long-term rates, has been making a positive contribution to the Composite Index of Leading Economic Indicators consistently for a year. The real M2 money supply, calculated as nominal M2 divided by the personal consumption expenditures price index, has barely missed a beat. In the last five years, there were only three months in which real money made a negative contribution to the LEI.

  Pretty soon some of the more tangible leading indicators -- the hard stuff everyone can relate to -- started to come around.

  Jobless claims, for example, made a positive contribution to the LEI in November, December and January. New orders for both non-defense capital goods and consumer goods rose in October, November and December before falling in January. (Both series are estimated for the LEI report since the orders data aren't yet released and revised the following month.) In January, the largest positive contributor to the LEI was vendor performance, which is a series from the Institute of Supply Management (formerly the National Association of Purchasing Management). The index of supplier deliveries jumped 3.7 points to 51.7 in January, the first reading above the 50 advance/decline line in almost a year.

  With vendor deliveries, a reading above 50 means slower deliveries, generally associated with a better economy. (In recession it's never a problem getting goods to a buyer.) Some analysts use the vendor delivery index as an inflation gauge because it suggests supply bottlenecks. In this case, in light of the huge inventory draw down, it seems more likely there's no stuff to send.

  "The huge jump in vendor deliveries suggests we're going to start to see a rebound in industrial production," says Mike Fort, manager of business cycle indicators at the Conference Board.

  The LEI rose 0.6 percent in January following December's huge 1.3 percent increase. January was the fourth consecutive monthly increase for the index.

  Even more encouraging was the jump in the six-month diffusion index to 60, the first reading above 50 in 21 months. The diffusion index measures the proportion of components that are rising.

  The interpretation is "pretty straightforward," Fort says.

  "The gist is that monetary policy initiatives are starting to spill over to other sectors."

  The Philadelphia Federal Reserve's Business Outlook Survey showed manufacturing activity increasing for the second consecutive month in February. Delivery times lengthened for the first time in 21 months.

  Philadelphia area manufacturers remain optimistic about the future, with the general activity diffusion index six months out at 51.8 in February, down from January's 53.2 reading. (Remember, 50 in the ISM Index corresponds to 0 in the Philly Fed.) The last time the future looked this bright was coming out of the 1990-1991 recession. In fact, such exalted levels of optimism are typical only at the end of recession.

  While survey respondents were encouraged about business prospects, they were worried about rising health benefit costs. In response to a special question, more than 40 percent said they expect health costs to rise 10 to 15 percent this year. About the same percentage said this would have a "significant" impact on their overall costs. Almost one-third of the respondents expect health costs to rise 15 percent or more.

  One option to defray the higher costs is for employers to ask employees to shoulder more of their health-care expenses, in which case it will show up in the consumer price index.

  The other option, since profit margins have already been squeezed, is to try to pass the higher costs along in the form of higher prices, in which case it will also show up in the CPI.

  Contrary to all the assertions that the CPI understates inflation because it doesn't adequately account for quality improvement of goods (more computer for lower price), the reverse -- the degradation of services -- never gets mentioned. Would anyone argue with the view that heath-care costs more and delivers less?
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