We all hear the pronouncements about different optimism indices, and they are usually portrayed as harbingers of the longer-term future. I recently had a pleasant conversation with a US Congressman in which he was telling me that the very high level in the Small Business Optimism Index meant that the economy was going to continue to expand and that the new tax law was “working” as designed. He told me that perception equals reality. ITR Economics, however, takes an analytical approach to our consulting work. We use leading indicators and ITR Checking Points™. The Small Business Optimism Index is not in our toolkit. Here is why:
Nondefense Capital Goods New Orders (excluding aircraft) (i.e., capital expenditure (CapEx) is a great tool for measuring B2B activity. The 12/12 rate-of-change (blue line on the graph) measures the business cycle pressure.
- 1. A look at the chart shows that the correlation is low, which means that the monthly optimism index throws off a lot of false signals. The fact that the Optimism Index is positive doesn’t give a strong indication of what to expect in CapEx.
- 2. The optimism index typically leads the CapEx 12/12 through highs (when it actually signals a high) by just one month (post the Great Recession). There is almost no advance warning from the index in regard to a coming shift in CapEx.
The Optimism Index reached a high in February of this year, signaling a March peak in the positive business cycle momentum in CapEx. Readers of the ITR Trends Report™ and ITR Insider™ know that a near-term peak is likely in CapEx, based on leading indicators that have a proven track record and look months into the future. The problem is that the Small Business Optimism Index gives almost no warning, and even worse, many people believe it is a harbinger of the longer-term future, when in fact it essentially looks no further than tomorrow.