What Is a Composite Leading Indicator?

Economists refer to certain indicators that allow them to assess the health of a regional economy at a given point in time. A composite leading indicator is an index created to produce some indication of what future economic conditions will be. The data is typically illustrated in the form of an index that is published by a research organization, such as The Conference Board, which represents North America, Europe and Asia. When the economy may be transitioning to a different cycle, a composite leading indicator could be a dependable resource to foretell changing conditions.

Many of the indicators that economists turn to to determine the resources of a community are representative of past activity. It is not uncommon to determine that a region has been in a recession, during which time an economy falters, once that downturn is already underway for months. A composite leading indicator represents multiple pieces of select data that, when combined, are relied upon by economists to predict the direction in which a regional economy is heading. Economists are not beholden to the group of items that are included in a composite leading indicator. If the index does not prove to meet the necessary requirements for successful predictions economists have been known to change those items.

One of the primary uses of a composite leading indicator is to recognize a change in the economic cycle. This could lead to the identification of an expansion when employment in a region is high and businesses are growing, or it could warn that an economy is showing signs of weakening. Although the items used to formulate a composite leading indicator represent activity that has already occurred, a composite index is still considered a barometer for future conditions. Economists apply complicated mathematical formulas to distinguish the existing economic environment from potential shifts in those elements.

Stock market investors often monitor the results of a composite leading indicator when making decisions on how to allocate capital. The state of an economy heavily influences the environment in which corporations must work to generate profits and sales. If there are signs that an economy is slowing, many companies are likely to face challenges tied to growing or even maintaining income. In turn, this can damage the way that investors perceive certain stocks and trigger selling in equity securities. Although a leading economic indicator may not be the only signal of a change in the economic or investment environment, it is one that economists and investors have turned for decades for some insight.