ARCHIVE: ECONOMIC PERFORMANCE AND TRENDS
Leading Indicator of Industry Profitability Predicts Recovery Will Continue
One year ago, The Conference Board of Canada introduced the Leading Indicator of Industry Profitability. Designed to predict turning points in corporate profitability three to six months hence, the indicator is performing this task well—it predicted both the weakening in profitability last summer and the subsequent recovery at the end of the year.
The good news for Canadians: the Leading Indicator of Industry Profitability Index has now risen for eight consecutive months. Most of the 49 industries covered—representing much of the private business activity taking place in Canada—have recorded gains during this period. The positive trend in the aggregate index and the breadth of the recovery across industries are signs that corporate profitability and the broader economy will improve over the course of 2011.
The strength of commodity prices and continued job creation are the key factors driving the promising outlook. Risks, however, include the recent pause in permitting activity (the total value of building permits issued by municipalities), the strong dollar, and expectations that interest rates will rise.
The Leading Indicator of Industry Profitability Index has now risen for eight consecutive months.
Although the Conference Board only began publishing the index in March 2010, available data allow the construction of a historical time series for each industry and the calculation of the aggregate index going back to 2001. (See Chart.) The results are clear.
- In fall 2007, the index predicted the 2008 surge in profitability.
- In summer 2008, the index peaked, coinciding with the period when profits peaked before the recession.
- In April 2009, the index predicted the post-recession recovery in profitability that started to materialize in the summer of that year.
- In 2010, the index predicted the decline in profits during the summer and forecast the subsequent recovery in profitability.
The Leading Indicator of Industry Profitability is produced monthly. An industry leading index is created for the economy as a whole, as well as for 49 individual sectors within the economy. To create the indicators, the Conference Board thoroughly investigated available high-frequency data (data published daily, weekly, or monthly) for each industry. Variables whose movement correlated with industry profitability six months later were included in the index for each of the 49 industries. These variables fall into three broad categories: demand drivers, prices, and costs.
- Demand drivers can be either direct (such as new orders for manufacturers and building permits for the construction industries) or indirect (such as labour market conditions for retailers).
- Prices include considerations as varied as output prices, interest rates, exchange rates, and stock prices.
- Costs focus on factors such as labour, energy, financing, and material inputs.
Even in periods where the index coincides with rather than leads changes in corporate profitability, it still has predictive power because the index is released well in advance—within five business days of the start of each month—of corporate profit data. For example, the May 2011 index is based on information available at the end of April, but profit data from the second quarter will not be released until the end of August.
The Leading Indicator of Industry Profitability is produced by the Conference Board’s Industrial Economic Trends group, which also publishes the Canadian Industrial Outlook Service (CIOS) and the Canadian Industrial Profiles (CIPS). The key factors driving the development of the indicator included broadening The Conference Board of Canada’s coverage to almost 50 industries (from 16 CIOS reports and 23 CIPS outlooks) and providing a high-frequency analysis of Canadian industrial performance.
Canadian Industrial Outlook Service
Canadian Industrial Profiles
Canadian Outlook Executive Summary: Spring 2011