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) -- The uptick in the Conference Board's latest reading on leading economic indicators can be traced to a troubling trend -- investors are fleeing stocks for the safety of cash.

The rise in the index for August, while better than expected, was neither good enough to inspire investors' confidence nor change economists' downbeat forecasts for a possible recession in the U.S.

The index, which pools ten economic figures, edged up 0.3% last month, extending an upwards trend in the prior three months. Yet, according to Ian Shepherdson, chief U.S. economist with High Frequency Economics, the increase is nothing to celebrate. He writes in a research note: "Ignore the positive headline."

"The biggest single driver of the increase in the leading economic indicators was the M2 money supply, which contributed a huge 0.7%," notes Shepherdson. He explains that people have turned away from the stock market, seeking safer ground in cash and deposits.

M2, which refers to the broad supply of money in the economy, has spiked in the last two months. If consumers are increasingly putting their wealth in cash, and checking and saving deposits, then the economic outlook may look worse, not better.

According to Shepherdson's calculations, by excluding contributions from money supply, manufacturing deliveries and the yield curve, the core measure of the index fell 0.7%. The last time the economy saw a drop like that was back in March 2009, he notes.

Four out of ten economic indicators in the Conference Board's report -- real money supply, interest rate spread, building permits, and supplier deliveries -- showed improvement. Meanwhile, indicators dragging down the headline figure included stocks prices, consumer expectations, weekly manufacturing hours, initial jobless claims, and manufacturing numbers.

Consensus estimates had called for a 0.1% gain in the leading indicators index.

expected the index to remain flat. The Conference Board's reading increased by 0.7% in May, 0.3% in June and 0.5% in July, suggesting that the economy is expanding, albeit at snail's pace.

The good news is that the headline number in August hasn't sounded the bell on a recession yet. The leading indicators report usually doesn't grab a lot of attention as economists tend to focus more on jobs and manufacturing numbers, but according to Francisco Torralba, economist with Morningstar Investment Management, investors should take note. It is the one indicator that has not predicted a recession because the twelve month percentage change in the index remained positive, he explained.

When the twelve month percentage change turns negative, historically, recessions have followed, said Torralba. However, he notes that there have been times when the economy has slipped into a recession even if the figure remains above zero, meaning that "the signal provides false positives but not false negatives."

On Wednesday, the Federal Reserve said that the U.S. economic outlook faces "significant downside risks," sparking renewed fears about a possible double dip recession. On Thursday, the three major averages extended late day losses from the previous session. The Dow and S&P 500 were both dropping close to 2.5%, heightening worries that a weak stock market would further chip away at confidence in the U.S. economy.

"There is growing risk that sustained weak confidence could put downward pressure on demand and business activity, causing the economy to potentially dip into recession," said Ken Goldstein, economist at The Conference Board, in the report. "While the chance of that happening remains below 50-50, the odds have certainly increased in recent months."

-- Written by Chao Deng in New York.

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Chao Deng


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