WASHINGTON — A widely watched barometer of future economic activity tumbled 1.2% in May, the Commerce Department reported Wednesday, reinforcing other warning signals of a rapidly slowing economy and renewing fears of impending recession.
It was the third drop in four months for the index of leading economic indicators and the largest monthly decline since November, 1987, immediately after the stock market crash.
Although economists regard the index as an imperfect predictor of the economy's course, they observed that the May index reflected slowdowns in nine of the 11 areas of economic activity that it measures.
"The number was big and the decline was broad-based, and that's disturbing," said David Wyss of Data Resources Inc., in Lexington, Mass., an economic forecasting firm that predicts the economy will slow to no growth at all by the end of the year.
"There wasn't just one major source of weakness; everything was soft," Wyss said. "It was a good picture of the economy, and it shows that May was a rotten month."
Financial markets evidently saw in the report a harbinger of shrinking corporate profits. Interest rates rose, and the Dow Jones industrial average lost 21.63 points to 2504.74.
"The message is that the weakness is broad-based," said Bruce Steinberg, an economist with the New York brokerage house of Merrill Lynch, which projects a brief and relatively mild recession beginning late in the summer.
Steinberg noted that the index reached a peak in January and has been declining gradually since. In the 44 years since World War II, Steinberg added, the average lag between a peak in the leading indicators and the ensuing recession has been nine months.
But recessions have not always followed. The index, propelled downward by the stock market crash, declined for five consecutive months at the end of 1987, but the economy confounded most predictions and rebounded strongly in 1988.
The White House declared itself unconcerned by the leading indicators. "The economy is healthy and growing at a slower pace, which means less pressure on inflation and interest rates," said spokesman Marlin Fitzwater. "We still think that the economy is in very good shape."
Like the index of leading indicators, other signals of economic activity recently have pointed downward. In two reports last Friday, the Commerce Department announced a 4.2% decline in factory orders for durable goods in May and a 0.3% decline in inflation-adjusted personal spending. Job growth in May declined to its lowest rate in three years.
Fed Seen as Key
Many economists believe that the Federal Reserve holds the key to whether the economy is slipping into recession. Richard W. Rahn, chief economist at the U.S. Chamber of Commerce, warned that a recession would surely follow if the Federal Reserve did not soon relax its still-tight grip on the money supply and allow interest rates to decline further.
The 0.3% decline in the money supply in May contributed substantially to the steep drop reported Wednesday in the index of leading economic indicators. Of the 11 indicators measured by the index, the only positives were contributed by the still-resurgent stock market and an uptick in building permits.
The hint that housing construction might be on the verge of recovery provided one hopeful sign that the current period of economic growth, in its seventh year and approaching the post-World War II record, might not be on the verge of ending.
"The cycles are not in sync," noted DRI's Wyss. "We now should be past the trough in housing, and exports should stay strong even while domestic consumption falls off."
By contrast, Allen Sinai of The Boston Co. Economic Advisers sees an actual recession, not just the slowdown forecast by DRI. He warned that "the economy could be sliding faster than we think." But Sinai also expects the service sector, which now contributes about two-thirds of the gross national product, to remain relatively stable, insulating the economy from a steep recession.
"Consumer spending has been flat and housing is in recession now and the main props are capital spending and exports," Sinai said. "If one or both of those fade, it's hard to see how the economy can stay afloat. But because services count for so much, they have to fade also for us to have the standard postwar 12-month recession."
The factors that contributed to the decline in the index of leading indicators, other than the decline in the money supply, were a drop in consumer confidence, a decline in prices of key industrial materials, a speedup in supply deliveries to manufacturers, a decline in the average workweek, a slowdown in orders for consumer goods, a decline in manufacturers' unfilled orders for durable goods, a slowdown in contracts for new plant and equipment and an uptick in unemployment claims.