Part III. Fundamental analysis / Chapter 16. Indicators of the business cycle and business optimism

Indicators of the business cycle and business optimism include:

• Leading Economic Indicators, LEI
• Institute for Supply Management, ISM, PMI
• Atlanta Fed Index
• Philadelphia Fed Index
• Chicago Purchasing Managers’ Index
• Empire State Manufacturing Survey;
• APICS Business Outlook Index.

The Leading Economic Indicators (LEI) is an index that reflects the overall state of the country's economy. It is compiled based on 11 leading economic indicators:

• Building permits for residential construction
• Average weekly initial claims for unemployment insurance
• Change in the price of raw materials and materials
• Supplier deliveries (measured by the companies reporting slower deliveries)
• New orders for capital goods and materials (based on 1982 prices)
• New orders for consumer goods and materials (based on 1982 prices)
• Unfilled orders for durable goods (based on 1982 prices)
• Money supply (M2) in US dollars (based on 1982)
• Average workweek in the manufacturing sector
• Consumer expectations index from the University of Michigan
• S&P stock market index (monthly average)

The data is collected monthly, and each indicator is assigned a weighting coefficient based on its significance. By using this composite index, conclusions can be drawn about future trends and changes in the economic situation.

The concept behind the Leading Economic Indicators is that profit expectations drive the economy. Companies invest in expanding production, providing services, and purchasing and upgrading equipment based on the anticipation of increased income. Naturally, during economic downturns, the expansion process slows down or comes to a halt due to lowered expectations

The Leading Economic Indicators (LEI) were developed to reflect the business cycle of the economy and predict turning points. Essentially, the 11 indicators that make up the LEI reflect business activity in different areas and cover important economic activity measures. Therefore, the LEI index, through the averaging of its constituent indicators, provides a better characterization of the sequential states of the business cycle than each individual indicator on its own.

It is considered that during periods of expansion, the average growth rate of the LEI is 0.2%, while during periods of recovery, it is 0.1%. During downturns, the LEI values decline at a rate of 0.3%. The LEI index is characterized by high volatility, which is approximately 0.8% during economic growth periods and 1.2% during recessions. Analysts have almost confirmed through historical data that the reversals of the LEI anticipate turning points in economic cycles. A strong signal is considered to be three consecutive declines, such as a monthly decline of 0.5-1%, which may indicate an impending economic downturn.

The next type of indicators we will discuss are business sentiment indices. These indices represent weighted data based on the opinions of business representatives. In recent times, these indicators have become increasingly popular as they reflect the confidence in the economic conditions of a particular country. In essence, these indices assess the subjective opinions of business circles. However, central banks have already started incorporating business sentiment indicators into their analysis, indicating their significance.

The construction of business sentiment indices is based on diffusion methods. Data for their calculation is collected through specially designed surveys targeting managers of companies, with the aim of evaluating economic activity as weakening, unchanged, or strengthening. The responsibility for these indicators lies with business associations and organizations, and despite their subjective nature, they are used for assessing public opinion and comparing them with objective indicators. Today, business sentiment indices are widely published in countries such as the United States, Germany, England, and Japan. For example, in Japan, the TANAKAN index, an analog of the American PMI index, is considered by the central bank when adjusting financial policy.

For each specific economic sector, the business sentiment index is calculated as the sum of the percentage of votes for "strengthening" and "unchanged" activity. The overall index is derived as the normalized value (considering seasonal factors) of the weighted sum of all the sector-specific indices based on their coefficients. It is believed that a thorough analysis of business sentiment indices can confidently forecast the development of the economy several months ahead.

The Purchasing Managers' Index (PMI), formerly known as the National Association of Purchasing Managers (NAPM), is one such business sentiment index. The PMI is a diffusion index that measures business optimism in wholesale purchasing. It brings together nearly 45,000 company managers. Data for the index is collected through a survey of 4,000 companies and includes reports on production output, orders, employment, inventories, import and export prices, and delivery times. The index is calculated by weighting the following components:

• Inventory levels (10%)
• Deliveries (15%)
• Employment (20%)
• Production (25%)
• Orders (30%)

The values are evaluated relative to a level of 43.8%, which indicates no growth in GDP. If the index value is above 50%, it indicates optimistic sentiment, expansion expectations, and prospects that can impact an increase in industrial sector orders. Values below 44% may anticipate an economic recession. Values between 44% and 50% suggest negative expectations.

An increase in the business sentiment index contributes to the strengthening of the dollar exchange rate. The dynamics of the index and the exchange rate have a directly proportional relationship. The data is published on the first business day of the month at 18:00 Moscow time.

The Atlanta Fed Index represents the business activity sentiment regarding the economic conditions of producers in Atlanta. The index values are evaluated relative to a zero level: values above 0 indicate an increase in business activity in the region, while values below 0 indicate a decrease. The growth of the index favors a stronger currency exchange rate. However, the influence of this index on the market is limited because the data is published after the release of the national-level ISM values. The reports for the index are released at 17:00 Moscow time after the 10th of each month.

The Philadelphia Fed Index, similar to the Atlanta Fed Index, is evaluated relative to a zero level and has limited influence on the market. The data is collected for the region including Pennsylvania, New Jersey, Delaware, and is published on the third Thursday of each month at 18:00 Moscow time. The release of the index values occurs earlier than the national-level ISM indicator, so the Philadelphia Fed Index can be used to forecast the ISM value.

The Chicago Purchasing Managers' Index (PMI) calculates values based on data from businesses in the Chicago region. The index values can significantly impact the currency exchange rate. In analytics, the Chicago PMI is used to analyze the National Association of Purchasing Managers' index. It is generally believed that values above 50 indicate increased activity in the region, while values below 50 indicate decreased activity. The data is published on the last business day of each month at 18:00 Moscow time.

The Empire State Manufacturing Survey is a relatively young indicator that began calculation in 2001. The values are based on surveys of managers in the manufacturing sector of the New York region. Despite its short history, the indicator has garnered interest from a wide audience. In analytics, this index is often used to forecast values for the Philadelphia Fed Index.

The APICS Business Outlook Index is used to forecast the values of the business activity indicator at the national level, as its influence on the market is relatively minor. Similar to the Chicago PMI, values are compared to the 50 level: values above 50 indicate growth, while values below 50 indicate a decline. Reports for the Outlook Index are published in the second half of the last business week of the month at 0:30 Moscow time.

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