If you’re investing, you’ve probably heard the term Economic Indicators before. It’s often mentioned alongside any big changes in the market whether it goes up or down. What exactly are they, and more importantly, how do they impact your portfolio?
Economic Indicators are used by policymakers, fund managers, and business owners to make important decisions. They provide valuable insight into what is happening in the economy. On a large scale, economic indicators help economists and government officials craft policy.
On a smaller scale these indicators help individual consumers and investors make decisions about their money. While investment decisions should not be made on these indicators alone, it is important to understand what they mean and how they might impact you.
The 3 Common Types of Economic Indicators
Economic indicators generally fall into three categories: leading, lagging and coincident. Here is a quick overview of each and when you might see them:
1. Leading Indicator
A leading indicator is one that can be used to predict changes in other economic metrics. An example of a leading indicator is the Index of consumer confidence. Economists and policymakers use leading indicators for forecasting and for creating fiscal and monetary policy.
2. Lagging Indicator
Lagging indicators show an economic trend that has already happened. Examples of lagging indicators include the unemployment rate and consumer price index (CPI). These indicators are used to confirm trends in the economy and identify turning points.
3. Coincident Indicator
Lastly, a coincident indicator is one that provides data about an economic event that’s currently happening. Examples of these indicators are gross domestic product (GDP), and retail sales. These indicators provide the closest thing to real-time data. Coincident economic indicators
The Core Economic Indicators Investors Should Know
While there are many economic indicators there are a handful that are reported frequently and considered to be the most important.
The gross domestic product (GDP) of a nation measures the value of all goods and services produced in the country during a particular period of time. GDP is a popular indicator of a nation’s overall economic health. The U.S. Department of Commerce reports the GDP quarterly. In general, an increase in the GDP is considered a positive trend. A decline is seen as negative.
GDP is reported in both nominal and real numbers. The nominal GDP doesn’t account for inflation so it is not as accurate. The real GDP subtracts the inflation rate from the GDP. And this gives a more accurate picture. What is more important than the GDP is the actual growth rate since the last reporting period. This shows if an economy has grown (or shrunk).
The Bureau of Labor Statistics released the unemployment rate each month. This is measured as the percentage of workers who are currently unemployed and are actively seeking and able to work. The unemployment rate excludes workers who are not actively seeking work.
Employment data is one of the most important and widely used metrics in the economy. In general, a low unemployment rate shows us that the economy is booming and that because businesses are hiring, they’re confident in their growth.
As a result, a low unemployment rate often has a positive impact on the stock market. On the other hand, a rising unemployment rate affects the stock market negatively. A rising rate shows businesses aren’t hiring and therefore may not be growing.
Consumer Price Index (CPI) and Interest Rates
The CPI is a measure of the prices of goods and services. This is measured by taking the average change of prices that customers pay for goods and services. This includes food, clothing, transportation, health care, and more. The CPI helps economists measure inflation (a rise in the prices of goods and services) or deflation (falling prices).
An interest rate is a percentage that lenders charge borrowers on loans and other debt. Interest rates are a tool that the Federal Reserve uses to control economic growth.
When the CPI is growing rapidly, the Fed often increases interest rates as a way to slow economic growth and therefore inflation. And when the economy is lagging, the Fed is likely to lower interest rates to stimulate economic growth.
Interest rates can be a useful tool for investors. They indicate how the government perceives the economy’s health to be. Interest rates also help individuals and businesses make purchasing decisions. A lower interest rate means it’s cheaper to borrow money.
People often make large purchases when interest rates are lower. For example, a small difference in interest rates can cost a borrower thousands of dollars over the life of a loan.
Consumer Confidence Index (CCI)
The Consumer Confidence Index (CCI) is a leading indicator that shows how consumers feel about the current state of the economy. Generally speaking when the consumers are confident in the economy retail sales go up. A rise in retail sales often can cause a rise in the stock market.
On the other hand, a decrease in consumer confidence and retail sales signals a lack of confidence by consumers and can cause a drop in the stock market.
Stock market broadly refers to all of the exchanges where the buying, selling, and issuance of shares of publicly traded companies takes place. The stock market is one of the most closely watched economic indicators. It is easy to see the effects on retirement plans and other investments. When people analyze stock market movement they usually consider key indexes like the S&P 500 or Dow Jones Industrial Average.
The stock market is generally proactive and indicates what investors expect to happen in the economy rather than what’s already happened. The stock market goes up if investors expect the economy to grow. On the other hand, if the stock market goes down investors expect an economic downturn.
How These Impact You
Economic indicators can be useful tools in understanding the current state of the economy and gaining insight into what may happen in the future. You can also gain some insight into why the Fed and policymakers make certain decisions.
While the indicators listed above are important, they need to be looked at in a broader context. An individual indicator may not provide much context and may not tell the whole story.
As always, investment decisions should be based on your specific situation and not only on what is happening in the economy. For example, if you are very close to retirement it is time to scale back on risk regardless of what the economic indicators are saying.
However, there are times when we can use these indicators to make decisions. An example of this is when interest rates may impact a large purchase decision or high stock market indexes may impact when to make a large investment.
It is also important to know that you don’t have to follow economic indicators to be a successful investor. Time in the market beats trying to time the market. Even the most successful fund managers and brightest economists can’t perfectly time the market.
With a long-term strategy of low cost investment, the ups and downs of the market won’t be as impactful.
We are here to help you put together a dynamic investment strategy that will work for you today and well into the future.