Analysts, economists, and governments use macroeconomic indicators to assess the economy and financial markets’ current and future health. They reflect the economic circumstances of a particular country, region, or sector.
Economic indicators can also help investors understand where the economy is going. They are some of the most valuable tools available to investors because some of these indicators can greatly impact how the stock market performs. Having a clear understanding of the different economic indicators and how they affect the stock market and the economy can give investors an advantage. It can help them finetune their timing on when to buy and sell securities and other assets, and it can also improve their portfolio management decisions.
In this article, we will discuss 10 of the most popular economic indicators. However, please be aware that some of these indicators predict an economy’s future movements and are not always reliable. Another thing to keep in mind is that broad trends can not be extrapolated from a single economic data point and that data and predictions can change rapidly.
What Are Economic Indicators?
Economic indicators are metrics and data that indicate the economy’s health and predict how well the economy will do in the future. These indicators are published daily, weekly, monthly, and/or quarterly by government agencies, non-profit organizations or universities, and even private companies. They provide measurements for evaluating the state of the economy and how consumers are doing and spending their money, corporate profits and predictions, and government spending and possible future government actions.
Many of the most popular indicators are published by the following institutions:
Many economic indicators provide nationwide information and have detailed industry breakdowns, which can be very useful to investors. In addition, some indicators provide regional information.
Investors can use economic indicators to make investment decisions. For example, if a set of economic indicators suggest that the economy will do better or worse in the future than it had previously expected, investors may decide to change their investing strategy.
Economic indicators can be classified by an indicators’ direction relative to the direction of the general economy. A procyclical indicator moves in the same direction as the economy, meaning that the indicator increases when the economy does well. Gross Domestic Product (GDP) is an example of a procyclical indicator. GDP is procyclical because it increases when the economy is performing well. When the economy is in a recession, GDP decreases. A countercyclical indicator moves in the opposite direction of the economy. For example, when the economy is doing well, the unemployment rate declines. An acyclical indicator has no relationship to the economy.
The 3 Different Groups of Economic Indicators, and How They Work?
There are 3 groups of economic indicators according to their timing in the business cycle: leading indicators, lagging indicators, and coincident indicators.
Leading Economic Indicators
Leading economic indicators are indicators that usually change before the economy changes. Thus, they point to future changes in the economy, and they are beneficial as short-term predictors of economic developments.
Investors generally rely mostly on leading economic indicators because these indicators can help forecast stock prices. However, the best way to use these indicators is to combine several of them to get insight into patterns and verify them with multiple data sets.
Because leading economic indicators can forecast where an economy is headed, fiscal policymakers and governments use them to implement fiscal policy programs. For example, they try to increase spending in a down economy or curb spending in an economy that is growing too fast.
Central banks also use leading indicators to make monetary policy decisions. For example, a central bank might increase interest rates to keep down inflation in a fast-growing economy. In contrast, it might reduce interest rates to increase spending in a sluggish economy.
If leading economic indicators do not meet expectations, this usually signifies that the economy will start a declining trend in the future, also called a bearish trend. In contrast, if these leading indicators beat expectations, this might indicate a booming economy in the future, also called a bullish trend. Some popular leading indicators are monthly unemployment claims, stock prices, consumer goods, material spending, and housing starts.
Many economists and analysts talk about the course of the economy and what they believe will happen. It is important to keep in mind that professionals are not always correct about leading economic indicators. There is no guarantee that they are right, and it is always a good idea not to follow their advice blindly but to do some analysis yourself. The U.S. Census Bureau publishes advance reports on various leading economic indicators that can be a helpful source of information.
Lagging Economic Indicators
Lagging economic indicators represent recent history and reflect the economy’s historical performance. Changes to these indicators are only visible after an economic trend or pattern has already been established. Thus, these economic indicators are handy for identifying turning points in the business cycle. Lagging indicators are technical indicators that follow significant economic changes.
Some examples of lagging indicators, such as Gross National Product (GNP), Consumer Price Index (CPI), unemployment rates, and interest rates, are only visible after real economic activities. Thus, these economic data sets represent data after the economy has changed.
Many people do not pay much attention to lagging indicators. Although they are not as important as leading indicators, these indicators should never be ignored. They can serve as a confirmation that you have been interpreting the leading indicators correctly. For example, these indicators can confirm that a recession has started or has ended or that a recovery is beginning.
There is an index of lagging indicators that the federal government uses. It is published monthly by the U.S. Conference Board, and it weighs seven different lagging indicators.
Coincident Economic Indicators
Coincident indicators change at about the same time as the economy changes. In other words, they provide information about the current state of the economy. Some coincident economic indicators are Gross Domestic Product (GDP), retail sales, employment rates, and personal income. A coincident index aims to identify, after the fact, the dates of peaks and troughs in the business cycle.
What Are the 4 Major Leading Economic Indicators?
Let us have a look at the top leading economic indicators that investors should familiarize themselves with:
1. Stock Market
Although the stock market is not the key leading predictor of the economy, many people look at it first to see where the economy is going. This is because stock prices are forward-looking and are based on investors’ and analysts’ expectations of the company’s future earnings. In addition, since stock prices are partly based on businesses’ anticipated sales, the stock market may indicate the economy’s course if the earnings forecasts are correct.
For instance, a strong stock market might mean that income forecasting is up, and the entire economy is preparing to flourish. Conversely, a downward market could display a decrease in company income and a recession in the economy.
There’s no question that the economy and the stock market are closely linked. However, one should not make the mistake of believing that the stock market is a perfect leading economic indicator. Some inherent issues rely on the stock market as an economic indicator because stock prices are often not based on a company’s true value but speculation and perceived value. This results in stocks getting overvalued or undervalued.
Take, for example, the DOTCOM bubble in the late 90s. Stock prices of many internet-related companies kept rising and created a false sense of optimism for the economy. But, unfortunately, the stock prices were so overvalued that eventually, in 2001, the bubble burst, and the market crashed. This bubble happened because traders and investors ignored other economic indicators. After all, they got distracted by the hype, the money, and the positive bullish market sentiment.
2. Inventory Levels
Inventory can be a good indicator of what direction the economy is heading in. However, it can be a tricky indicator to interpret, and it is best used in conjunction with the Manufacturing Levels indicator. High inventory levels can mean two different things. They either are the result of anticipated growth in inventory demand or a current lack of demand.
In the first example, companies target to build up inventories to brace themselves for higher demand in the next months. If market behavior rises as expected, high-inventory companies may meet demand and thus increase their profit. In the second example, where there is a lack of demand, higher inventories indicate a future slowdown.
3. Building Permits and Housing Starts
Building permit activity provides an insight into housing and overall economic activity in the upcoming months. They lead housing starts, but because they are not required in all regions of the country, the number of permits tends to be lower than the number of housing starts over time.
The housing starts data and building permit data indicate the demand for newly built homes. High housing start numbers are a key indicator of economic well-being. It reflects high levels of employment and consumer confidence. It also has a positive effect on the demand for financing and materials.
However, if more houses are constructed than buyers are willing to purchase, housing prices will likely decrease, and employment numbers and consumer confidence will decline. This can be an indicator that the economy as a whole will start a downturn soon.
4. Production and Manufacturing Statistics
Manufacturing activity is another leading economic indicator of the economy as it influences the GDP (Gross Domestic Product) strongly. An increase in production indicates that the economy will start growing as it suggests a higher demand for consumer goods, which will boost employment and possibly wages.
However, increases in manufacturing activity can also be misleading. For example, sometimes, the goods produced do not get sold and might sit in inventory for a while. This is not a good development as it is expensive to store products. Therefore, when looking at manufacturing data, it is important to look at retail sales data. If both retail sales and manufacturing activity are on the rise, there is an increase in demand for consumer goods, and the economy will grow. However, if there is not enough demand for the manufactured products and they sit in inventory for a long time, this might indicate that the economy will slow down.
What Are the 2 Major Coincident Economic Indicators?
Here is a look at the two top coincident economic indicators that investors should familiarize themselves with:
1. Gross Domestic Product (GDP) growth
GDP represents the total market value of all goods and services produced by an economy over a certain time period. Economists, analysts, and investors consider GDP to be the most important measure of the economy’s current health. When GDP increases, it is a sign that the economy is strong. In fact, when GDP increases, many other economic indicators increase because businesses will increase expenditures on inventory, salaries, and other investments, and consumer confidence will rise, which will increase retail sales.
The GDP of the United States is calculated by adding the following figures in the U.S. economy together: U.S. personal and public consumption; public and private investment; government spending; and exports (minus imports).
The U.S. GDP number is reported quarterly by the Bureau of Economic Analysis. It is considered a periodic measure of how the economy is doing, while the annual GDP numbers are used as the benchmark for the U.S. economy’s overall size.
Real GDP factors in inflation, meaning it accounts for the overall rise in price levels. Economists generally prefer using real GDP as a way to compare a country’s economic growth rate. Nominal GDP takes current market prices into account without factoring in inflation.
Economists compare GDP between different periods to assess how the economy is doing. If there is positive growth, the economy is growing. Conversely, it can indicate that the economy is in a recession or approaching a recession or an economic downturn if there is negative GDP growth.
Investors use GDP numbers because a significant change in GDP can significantly impact the stock market. If GDP has gone down, it indicates a downturn in the economy and usually means lower earnings and lower stock prices.
2. Retail Sales
Retail sales are another significant coincident indicator because consumer spending has a large impact on the economy. When consumer confidence is high and people start spending more, there is a rippling effect on the economy. Manufacturers will make more products, service providers will be busier, employment rates will increase, and the overall economy will get a boost.
However, when consumer confidence goes down, people will hold off on buying discretionary items and other things they can live without, and the economy slows down. When this happens, sometimes the government will step in and offer tax rebates or other types of stimulus to get consumers to start spending more. The best example of this is the Coronavirus $2 trillion stimulus package the U.S. federal government gave to the American people to mitigate hardships like unemployment, lost revenue, and inability to make payments on loans.
Strong retail sales directly increase GDP. However, there is a downside to retail sales as an indicator because it does not consider how people pay for their purchases. If consumers purchase goods on credit but later cannot pay back the loans, it could signify an upcoming recession. However, in general, an increase in retail sales indicates a flourishing economy.
What Are the 4 Top Lagging Economic Indicators?
Now that you are well aware of the major leading and coincident economic indicators let us look at the major lagging economic indicators.
1. Unemployment Rate
One of the most widely recognized lagging indicators is the unemployment rate. It measures the number of people looking for work as a percentage of the total labor force. In a healthy economy, the unemployment rate will be anywhere from 3% to 5%.
Unemployment does not just affect unemployed people. It impacts the economy as a whole. A high unemployment rate hurts disposable income, purchasing power, and employee morale. This creates a ripple effect in the economy and starts impacting even those who still have jobs.
If the unemployment rate increases over a longer period of time, it indicates that the overall economy has declined. Businesses have started to give up hope that the situation will improve and have started to lay off their workers. Unemployment will usually continue to rise for a while, even after the economy is back on track. Companies wait until they believe the economy has recovered before they start hiring again.
Like most other indicators, the unemployment rate can be misleading. People are classified as unemployed when they do not have a job, are available to work, and have actively been looking for work in the last 4 weeks. This definition considers those with part-time work to be fully employed and does not account for discouraged workers who have stopped actively looking for a new job. Therefore, the official unemployment rate may actually be significantly understated.
2. Inflation/Consumer Price Index
The Consumer Price Index (CPI) represents the increased cost of living or inflation. The CPI is calculated by measuring the costs of essential goods and services such as shelter, clothing, food, and medical care. The average increased cost of this basket of goods over a period of time determines inflation.
Inflation is a lagging indicator, as it is the result of economic growth. During periods of economic growth, there is likely to be an increase in inflation. When the economy is growing, the demand for products increases, which usually results in higher prices.
When the CPI average increases faster than the consumers’ income increases, inflation, and the consumers’ purchasing power decline. Inflation reduces the average standard of living and leads to decreases in the employment rate and GDP.
High inflation rates often lead to rising interest rates as governments attempt to get prices under control.
3. Income and Wages
Income is another important lagging indicator. Incomes and wages usually do not start to increase until the economy has been growing for a while. When companies feel confident that their business will keep growing, they will increase salaries to attract more employees to keep up with demand and keep their current employees happy.
However, when the economy is declining, incomes usually start declining as well. As a result, employers have to either cut pay rates, lay off workers, or reduce their hours to stay competitive. Declining incomes can also reflect an environment where investments are not performing as well.
Income statistics are divided into various categories, such as gender, age, ethnicity, and education. These categories provide an insight into how incomes for different groups change. This is crucial because a pattern affecting only one group does not mean that the country as a whole sees an increase or decrease in income.
4. Corporate Profits
Although it might seem that corporate profits are a leading indicator, they act more as a lagging indicator.
High profits are definitely correlated with a rise in GDP because they reflect increased sales and encourage job growth. High profits also increase stock market performance as investors look for places to invest. However, there is a problem with using corporate profits as a leading indicator.
The problem is that profits are not visible until well after the fact. Corporate earnings are released after the fact, and the Bureau of Economic Analysis (BEA) reports quarterly profits with a 3-month time lag. Besides, who knows for sure if a one-quarter decline is the beginning of a recession or just an anomaly? To make sure, you might want to wait for the second quarter of published earnings. However, if you do that, you are already dealing with a 9-month time lag. That is why corporate profits should be considered a lagging indicator.
Economic indicators are only useful if you know how to interpret them correctly. For example, there is a strong correlation between a growing economy and growing corporate earnings. However, the problem is that there is no single economic indicator that can tell you for sure if a particular company can increase its earnings. Not even a significant increase in GDP, the leading indicator, can guarantee that a company will become more profitable.
It’s crucial not to tie your expectations to one period of data for one indicator. Instead, the best way to use economic indicators is to combine several of them over several periods to see if there is a trend, get insight into patterns, and verify them.
Investors generally rely mostly on leading economic indicators because these indicators can help forecast stock prices. Therefore, understanding the leading economic indicators and tracking them will help you make wise investments and financial decisions.
While there is no magic economic indicator that can tell you when to buy or sell stocks, using the data from several economic indicators in conjunction with other analyses such as fundamental and technical analysis can lead to more profitable investments.