The Leading Economic Indicators Index
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23 Apr 2023 03:16:41 pm.
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The Leading Economic Indicators Index
Economic indicators can be divided into categories or groups. Most of these economic indicators have a specific schedule for release, allowing investors to prepare for and plan on seeing certain information at certain times of the month and year.
Leading Indicators
Leading indicators, such as the yield curve, consumer durables, net business formations, and share prices, are used to predict the future movements of an economy. The numbers or data on these financial guideposts will move or change before the economy, thus their category's name. Consideration of the information from these indicators must be taken with a grain of salt, as they can be incorrect.
Investors are most often interested in leading indicators, as a correctly placed leading indicator means certain measures correctly predicted the future. Leading indicators are prepared making broad economic assumptions. For example, many investors track forward-looking yield curves to project how future interest rates may dictate stock or bond performance. This analysis relies on historical data; based on how investments performed the last time the yield curve was a certain way, some may assume those same investments will repeat their performance.
Coincident Indicators
Coincident indicators, which include such things as GDP, employment levels, and retail sales, are seen with the occurrence of specific economic activities. This class of metrics shows the activity of a particular area or region. Many policymakers and economists follow this real-time data, as it provides the most insight into to what is actually happening. These types of indicators also allow for policymakers to leverage real data without delay to make informed decisions.
Coincident indicators are somewhat less helpful to investors, as the economic situation has already blossomed. As opposed to a forecast or a prediction, a coincident indicator informs investors of what is actually happening in the present. Therefore coincident indicators are only useful to those who can correctly interpret how economic conditions today (i.e. falling GDP) will impact future periods.
Lagging Indicators
Lagging indicators, such as gross national product (GNP), CPI, unemployment rates, and interest rates, are only seen after a specific economic activity occurs. As the name implies, these data sets show information after the event has happened. This trailing indicator is a technical indicator that comes after large economic shifts.
The problem with lagging indicators is the strategy or response to these indicators may be too late. For example, by the time the Federal Reserve interprets CPI data and decides how best to enact monetary policy to stem inflation, the numbers they are observing are slightly outdated. Though lagging indicators are still used by many governments and institutions, they also pose the risk of guiding incorrect decision-making due to incorrect assumptions about present-day economics.
Indicators provide signs along the road, but the best investors utilize many economic indicators, combining them to glean insight into patterns and verifications within multiple sets of data.
Interpreting Economic Indicators
An economic indicator is only useful if one interprets it correctly. History has shown strong correlations between economic growth, as measured by GDP, and corporate profit growth. However, determining whether a specific company may grow its earnings based on one indicator of GDP is nearly impossible.
There is no denying the objective importance of interest rates, gross domestic product, and existing home sales or other indexes. Why objectively important? Because what you're really measuring is the cost of money, spending, investment, and the activity level of a major portion of the overall economy.
Like many other forms of financial or economic metrics, economic indicators hold tremendous value when compared across a period of time. For example, governments may observe how unemployment rates have fluctuated over the past five years. A single instance of unemployment rates doesn't yield much value; however, comparing it to prior periods allows analysts to better gauge a statistic.
In addition, many economic indicators have a benchmark set, whether by a government agency or other entity. Consider how the Federal Reserve's target rate of inflation is usually 2%. The Federal Reserve then enacts policies based on CPI measurements to achieve this target. Without this benchmark, analysts and policymakers wouldn't know what makes a good indicator's value good or poor.
The Stock Market As an Indicator
Leading indicators forecast where an economy is headed. One of the top leading indicators is the stock market itself. Though not the most critical leading indicator, it’s the one that most people look at. Because stock prices factor in forward-looking performance, the market can indicate the economy’s direction, if earnings estimates are accurate.
A strong market may suggest that earnings estimates are up, which may suggest overall economic activity is up. Conversely, a down market may indicate that company earnings are expected to suffer. However, there are limitations to the usefulness of the stock market as an indicator because performance to estimates is not guaranteed, so there is a risk.
Also, stocks are subject to price manipulations caused by Wall Street traders and corporations. Manipulations can include inflating stock prices via high-volume trades, complex financial derivative strategies and creative accounting principles—both legal and illegal. The stock market is also vulnerable to the emergence of “bubbles,†which may give a false positive regarding the market’s direction.
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