Leading Indicator

Q: Sarah, a portfolio manager, observes that the Conference Board Leading Economic Index has declined for three consecutive months. Building permits are down 15%, the yield curve has inverted (short-term rates exceed long-term rates), and consumer confidence has fallen sharply. Corporate earnings remain strong, and unemployment is at historic lows. How should Sarah interpret these signals for her client portfolios?

**B is correct.** Multiple leading indicators (LEI decline, falling building permits, inverted yield curve, weak consumer confidence) are signaling a potential recession 6-12 months ahead. Strong earnings and low unemployment are lagging indicators that confirm current conditions but do not predict future changes. Shifting to defensive sectors is prudent when leading indicators deteriorate. A is incorrect because it relies on lagging indicators (earnings, unemployment) while ignoring multiple warning signals from leading indicators that predict future conditions. C is incorrect because while declining building permits might correlate with future rate cuts, the combination of negative leading indicators suggests defensive positioning, not aggressive growth exposure. D is incorrect because leading indicators have demonstrated predictive value; ignoring them would be imprudent risk management.

Q: Which of the following is considered a leading economic indicator?

**C is correct.** Building permits for new housing are a leading indicator because they predict future construction activity, employment, and related economic expansion or contraction 6-12 months ahead. When permits decline, it signals future economic weakness. A (unemployment rate) is a lagging indicator that confirms economic changes after they have occurred; unemployment continues rising even after a recession ends. B (corporate earnings) is a lagging indicator that reports past performance, not future activity. D (GDP growth rate) is a coincident indicator that moves with the current state of the economy rather than predicting future changes.

Q: An investment adviser tracks several economic indicators during the first quarter: the S&P 500 index has declined 12%, new manufacturing orders have fallen for two consecutive months, and the unemployment rate remains at 3.8% (unchanged). Based on leading indicator analysis, which scenario is most likely over the next 6-9 months?

**B is correct.** The stock market (down 12%) and declining manufacturing orders are both leading indicators that predict future economic weakness 6-9 months ahead. The stable unemployment rate is a lagging indicator that confirms current conditions but does not predict future activity. When leading indicators decline, economic contraction typically follows. A is incorrect because unemployment is a lagging indicator; it remains low during the early stages of economic deterioration and only rises after contraction begins. C is incorrect because the signals are not mixed; both leading indicators point to weakness while only the lagging indicator shows stability. D is incorrect because while declining stock prices may create buying opportunities, they are also a leading indicator warning of future economic weakness, not accelerating expansion.

Q: All of the following are examples of leading economic indicators **EXCEPT**

**C is correct (the EXCEPT answer).** Average duration of unemployment is a lagging indicator that confirms economic conditions after they have already changed. It continues rising even after a recession ends and only improves well into recovery. A is accurate: the stock market (S&P 500) is a leading indicator that typically predicts economic turning points 3-9 months ahead because investors price in future corporate earnings expectations. B is accurate: new manufacturing orders are a leading indicator because they predict future production, employment, and economic activity. D is accurate: the consumer confidence index is a leading indicator because consumer spending intentions predict future economic activity; when confidence falls, spending typically declines in subsequent months.

Q: An economist presents data showing that the yield curve has inverted (10-year Treasury yields below 2-year yields) for the first time in 8 years. The stock market has declined 8% over the past two months, and building permits have fallen 10%. Which of the following statements about leading indicators are accurate? 1. These signals suggest a recession is likely within the next 12-18 months 2. Leading indicators are perfectly accurate predictors of economic downturns 3. The yield curve inversion is historically a reliable leading indicator of recessions 4. Investment advisers should ignore these signals until unemployment begins rising

**A is correct.** Only statements 1 and 3 are accurate. Statement 1 is TRUE: Multiple declining leading indicators (yield curve inversion, falling stock prices, declining building permits) historically predict recessions 6-18 months ahead. The combination strengthens the signal. Statement 2 is FALSE: Leading indicators are NOT perfectly accurate; they can give false signals. For example, yield curve inversions have occasionally occurred without a subsequent recession, and the stock market has predicted "nine of the last five recessions" (famous economist Paul Samuelson quote). Leading indicators provide probability, not certainty. Statement 3 is TRUE: Yield curve inversion (short-term rates exceeding long-term rates) has preceded every U.S. recession since 1955, making it one of the most reliable leading indicators, though not infallible. Statement 4 is FALSE: Waiting for unemployment to rise before acting would be a mistake because unemployment is a lagging indicator that confirms recessions after they begin. Investment advisers should respond to leading indicator signals proactively, not wait for lagging confirmation.

Economic Factors High Relevance

Economic indicators that typically change direction before the overall economy, helping predict future economic activity 3-12 months ahead. Common leading indicators include stock market performance, building permits, new manufacturing orders, consumer confidence, yield curve, and initial jobless claims. Not perfectly accurate; false signals can occur.

Example

When building permits and new housing starts decline sharply, this often signals an economic contraction 6-9 months later as the construction industry slows, leading to reduced employment and spending in related sectors.

Common Confusion

Students often confuse leading indicators (predict future changes), lagging indicators (confirm past changes like unemployment rate), and coincident indicators (move with the economy like GDP). Also, leading indicators are not always accurate and can give false signals.

How This Is Tested

Identifying which economic indicators are leading vs. lagging vs. coincident
Understanding that leading indicators predict future economic activity 3-12 months ahead
Recognizing that the stock market is a leading indicator that can predict economic turning points
Determining investment strategy adjustments based on changes in leading indicators
Understanding that leading indicators are most volatile and can give false signals

Regulatory Limits

Description	Limit	Notes
Typical lead time range	3-12 months	How far ahead leading indicators typically predict economic changes

Example Exam Questions

Test your understanding with these practice questions. Select an answer to see the explanation.

Question 1

Sarah, a portfolio manager, observes that the Conference Board Leading Economic Index has declined for three consecutive months. Building permits are down 15%, the yield curve has inverted (short-term rates exceed long-term rates), and consumer confidence has fallen sharply. Corporate earnings remain strong, and unemployment is at historic lows. How should Sarah interpret these signals for her client portfolios?

Question 2

Which of the following is considered a leading economic indicator?

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Question 3

An investment adviser tracks several economic indicators during the first quarter: the S&P 500 index has declined 12%, new manufacturing orders have fallen for two consecutive months, and the unemployment rate remains at 3.8% (unchanged). Based on leading indicator analysis, which scenario is most likely over the next 6-9 months?

Question 4

All of the following are examples of leading economic indicators EXCEPT

Question 5

An economist presents data showing that the yield curve has inverted (10-year Treasury yields below 2-year yields) for the first time in 8 years. The stock market has declined 8% over the past two months, and building permits have fallen 10%. Which of the following statements about leading indicators are accurate?

1. These signals suggest a recession is likely within the next 12-18 months
2. Leading indicators are perfectly accurate predictors of economic downturns
3. The yield curve inversion is historically a reliable leading indicator of recessions
4. Investment advisers should ignore these signals until unemployment begins rising

💡 Memory Aid

Think of leading indicators as headlights on a car at night: they show you what's coming BEFORE you reach it. Stock market goes down before recession (predicts trouble ahead), unemployment goes up after recession starts (confirms you're already there). Remember: "Leaders lead, laggers lag" – leading indicators move FIRST (3-12 months ahead), lagging indicators move LAST (after the change).

Related Concepts

This term is part of this cluster:

📊 Macro Economy

Leading Indicator