Leading Index for Indiana fell in May, but decline seen as temporary
June 18, 2010
BLOOMINGTON, Ind. -- After rising in March and April, the Leading Index for Indiana (LII) fell in May.
"Amidst troubling economic events like the Gulf oil spill and a more than 10 percent drop in the stock market, the LII retreated in May," observed Timothy Slaper, director of economic analysis at the Indiana Business Research Center at Indiana University's Kelley School of Business. "The LII's reversal suggests that the economic recovery will continue to be slow.
"Much of the LII's pullback, however, can be attributed to investor jitters over the economy both domestically and in the European Union, signaling that May's retreat is only temporary," Slaper added.
In contrast to the LII's setback in May, most economic indicators have moved in the positive direction recently. The Conference Board's Consumer Expectations index rose to pre-recession levels. In the automotive sector -- especially relevant to Indiana's economic fortunes -- floor traffic at dealerships in May reached its highest point since the end of the Cash for Clunkers program.
The percentage of consumers expecting business conditions to improve over the next six months rose above 20 percent in May. While the magnitude of change differs across indicators, the direction of change has been widely positive.
The LII is produced each month by the Indiana Business Research Center.
Drivers of Change
According to the NAHB/Wells Fargo Housing Market Index (HMI), home builders' confidence in the market fell to its lowest level since March, a decline thought to be fueled by the expiration of the home buyer tax credit. The index plummeted 5 points from 22 to 17. All three components of the index fell, as did all five regional indices.
"As the HMI data show, builders remain very cautious and are concerned about financing for the production and purchase of housing, faulty appraisal practices, and the inventory of foreclosed properties dampening any emerging housing recovery," Slaper said.
The Dow Jones Transportation Average (DJTA) dropped in May, reversing the 6.6 percent gain from April, and settling below the March level.
"Much of this decline, however, can be attributed to the overall stock market drop last month," Slaper said. "The Dow Jones Transportation Average's decline had the largest negative effect on the LII this month."
According to the Purchasing Managers Index (PMI), manufacturing continues to expand, but at a slightly slower pace. The Institute of Supply Management reports that, after rapid growth in March and incremental growth in April, the May PMI dropped 0.7 percentage points, almost reversing April's gain.
A PMI value above 50 signifies that the manufacturing economy is expanding, and at 59.7, the May PMI still signals growth.
The federal funds rate remains close to zero as part of the Federal Reserve's plan to thaw the financial sector. The 10-year Treasury rate dropped in May to its lowest level since November, most likely from increased demand for Treasuries as investors shifted away from stocks.
"The resulting increase in the interest rate spread might encourage banks to increase lending to less attractive borrowers," Slaper said. "Large spreads were also evident as the economy picked up speed out of the recessions in 1992 and 2003.
"Based on this experience, some economy watchers have argued that the persistently large spread is a sign that the economic upturn will be more dramatic than the widely predicted 'U' shape recovery," he added. "These predictions, made six months ago, have yet to materialize and the recovery has yet to find its legs."
The auto sector component of the index has been flat. On the other hand, the sector has shown some signs of life. Floor traffic at dealerships in May reached its highest point since the end of the Cash for Clunkers program.
"Several industry analysts have revised their sales estimates for 2010 slightly upward," Slaper noted. "This is largely because Americans are now driving more than during the depths of the recession. More miles driven translates into the need to replace the vehicles. In the not too distant future, the pent-up demand for cars will translate into auto sales."
About the Leading Index for Indiana
The LII, developed by the Indiana Business Research Center (www.ibrc.indiana.edu/), 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.