Compass Points: Economic Commentary

Can Low Inflation and Strong Growth Continue in the US?

Tools for forecasting growth in your business
by Denise A. Harrison

In order to keep the strong US growth trend the following must continue:

The dollar must remain strong to prevent the trade deficit from widening.
Raw materials increases must not be passed on to the consumer.
Productivity gains must offset both raw materials and labor cost increases.
Liquidity, money for investment, must continue to be available. (Graph #1)

GDP and Money Supply Growth

Previously strong US growth invigorated the world economy. Now as many regional economies start the road to recovery, export demand for US goods and services increases. (See Graph #2)

Economic prosperity - will it continue? In our last issue we evaluated how productivity gains and demographics were elements contributing to a positive long term outlook for the US economy. What about the short-term hiccups? When a company develops a 3-5 year strategy the long-term trends must be coupled with the short-term opportunities and threats.

Watching indices that are relevant for your business, such as Leading Indicators, can be very useful in forecasting future growth. During our seminar you learned about the Index of Leading Indicators, produced monthly by the Conference Board. In last year’s winter issue of Compass Points we reviewed the make-up of the index. Many of our readers have asked for a more detailed description of the index so that the impact on a particular business could be better understood. By understanding the components of the index you can better determine whether or not it is a predictive index for your business.

The Conference Board gives the following description of each of these statistics.

Average weekly hours manufacturing:
The hours worked per week by production workers in manufacturing industries tend to lead the business cycle because employers usually adjust work hours before increasing or decreasing their workforce.
Average weekly claims for unemployment insurance:
The number of new claims filed for unemployment insurance are typically more sensitive than either total employment or unemployment to overall business conditions, and this series tends to lead the business cycle. The signs of the month-to-month changes are reversed, because initial claims increase when employment conditions worsen.
Manufacturers’ new orders, consumer goods and materials:
These goods are primarily used by consumers. The inflation-adjusted value of new orders leads actual production because new orders directly affect the level of both unfilled orders and inventories that firms monitor when making production decisions.
Vendor performance, slower deliveries:
This index measures the relative speed at which industrial companies receive deliveries from their suppliers. Slowdowns in deliveries increase this series and are most often associated with increases in demand for manufacturing supplies and, therefore, tend to lead the business cycle.
Manufacturers’ new orders, nondefense capital goods (1992 $):
New orders received by manufacturers’ in nondefense capital goods industries are the producers counterpart to new orders of consumer goods and materials.
Building permits, new private housing units:
The number of residential building permits issued is an indicator of construction activity, which typically leads most other types of economic production.
Stock prices, 500 common stocks:
The Standard and Poor’s 500 stock index reflects the price movements of a broad selection of common stocks traded on the New York Stock Exchange. Increases of the stock index can reflect both the general sentiments of investors and the movements of interest rates, which is usually another good indicator for future economic activity.
Money Supply (in 1992 $):
In inflation adjusted dollars, this is the M2 version of the money supply. When the money supply does not keep pace with inflation, bank lending may fall in real terms, making it more difficult for the economy to expand. M2 includes currency, savings deposits, small denomination time deposits, and balances in money market mutual funds.
Interest rate spread, 10-year Treasury bonds less federal funds:
The spread or difference between long and short rates is often called the yield curve. It is felt to be an indicator of the stance of monetary policy and general financial conditions because it rises when short rates are relatively low. When it becomes negative (short rates higher than long rates) its record, as an indicator of recessions, is particularly strong.
Index of consumer expectation:
This index reflects changes in consumer attitudes concerning the future economic conditions and, therefore, is the only indicator in the leading index that is completely expectation based. Data are collected in a monthly survey conducted by the University of Michigan’s Survey Research Center. Responses to questions concerning various economic conditions are classified as positive, negative, or unchanged. The expectations series is derived from the responses to three questions relating to: 1.The economic prospects for the respondent’s family over the next 12 months; 2. The economic prospects for the Nation over the next 12 months; 3. The economic prospects for the Nation over the next five years.

If the index of leading indicators turns down for three consecutive months or turns down by 1% in one or two months combined, it is a signal for a recession.

What about your business?

Is this index an accurate predictor? In order to evaluate its effectiveness for your business look at the components and decide whether or not they impact your business directly or your customers’ business. If not, discuss what would be appropriate with your team.

Many raw materials based industries did not enjoy the prosperity of the economic boom with the rest of the country, so companies in industries such as steel, paper, oil should include their respective raw materials prices in their own leading indicators. As prices go up, worldwide demand is growing, as prices go down, excess capacity may be producing excess supply, or overall worldwide demand may be slipping. For these industries understanding the supply-side of the equation is paramount to forecasting future industry growth.

Is your industry counter-cycle? If so, when the leading indicators go down, you may be in for an upturn. The collections business is a good example of a counter-cycle business.

Is your business dependent on government spending? Then watch total government expenditures along with specific line items as they go through the annual Congressional budgeting process. It is important for your business to understand the overall health of the economy, both US and internationally, however you must also evaluate the specific variables that give your team an early indication of things to come. This understanding will enable your company to position itself by balancing both the long-term and short-term opportunities.

Denise Harrison lives in Wilmington, North Carolina and is a consultant for the Center for Simplified Strategic Planning. She presents the workshop, Simplified Strategic Planning for Small to Mid-Sized Companies. For more information about Denise, check out her bio page.

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