Research

KnowRisk: Economic Indicators: Financial Signposts

Introduction
An economic indicator is simply any economic statistic, such as the unemployment rate, Gross Domestic Product, or the inflation rate, which indicate how well the economy is doing and how well the economy is going to do in the future. If a set of economic indicators suggest that the economy is going to do better or worse in the future than they had previously expected, investors may decide to change their investing strategy.

To understand economic indicators, we must understand the ways in which economic indicators differ. There are three major attributes each economic indicator has:

Three Attributes of Economic Indicators

Relation to the Business Cycle / Economy

Economic Indicators can have one of three different relationships to the economy:

  • Pro-Cyclic: A pro-cyclic (or pro-cyclical) economic indicator is one that moves in the same direction as the economy. So if the economy is doing well, this number is usually increasing, whereas if we’re in a recession this indicator is decreasing. The Gross Domestic Product (GDP) is an example of a pro-cyclic economic indicator.
  • Counter-Cyclic: A counter-cyclic (or counter-cyclical) economic indicator is one that moves in the opposite direction as the economy. The unemployment rate gets larger as the economy gets worse so it is a counter-cyclic economic indicator.
  • Acyclic: An acyclic economic indicator is one that has no relation to the health of the economy and is generally of little use. The number of home runs the New York Yankees hit in a year generally has no relationship to the health of the economy, so we could say it is an acyclic economic indicator.

Frequency of the Data
In most countries GDP figures are released quarterly (every three months) while the unemployment rate is released monthly. Some economic indicators, such as the Dow Jones Index, are available immediately and change every minute.

Economic indicators can be leading, lagging, or coincident relative to the economy.

Timing
Economic Indicators can be leading, lagging, or coincident which indicates the timing of their changes relative to how the economy as a whole changes.

Three Timing Types of Economic Indicators

Leading: Leading economic indicators are indicators which change before the economy changes. Stock market returns are a leading indicator, as the stock market usually begins to decline before the economy declines and they improve before the economy begins to pull out of a recession. Leading economic indicators are the most important type for investors as they help predict what the economy will be like in the future.
Lagged: A lagged economic indicator is one that does not change direction until a few quarters after the economy does. The unemployment rate is a lagged economic indicator as unemployment tends to increase for 2 or 3 quarters after the economy starts to improve.
Coincident: A coincident economic indicator is one that simply moves at the same time the economy does. The Gross Domestic Product is a coincident indicator.

Next we will look at some of the economic indicators distributed by the U.S. Government.

Many different groups collect and publish economic indicators, but the most important American collection of economic indicators is published by The United States Congress. Their Economic Indicators are published monthly and are available for download in PDF and TEXT formats. The indicators fall into seven broad categories:

  • Total Output, Income, and Spending
  • Employment, Unemployment, and Wages
  • Production and Business Activity Prices
  • Money, Credit, and Security Markets
  • Federal Finance
  • International Statistics

Each of the statistics in these categories helps create a picture of the performance of the economy and how the economy is likely to do in the future.

Total Output, Income, and Spending

These tend to be the broadest measures of economic performance and include such statistics as:

  • Gross Domestic Product (GDP)
  • Real GDP
  • Implicit Price Deflator for GDP
  • Business Output
  • National Income
  • Consumption Expenditure
  • Corporate Profits
  • Real Gross Private Domestic Investment

These statistics are all updated quarterly. The Gross Domestic Product is used to measure economic activity and thus is both pro-cyclical and a coincident economic indicator. The Implicit Price Deflator is a measure of inflation. Inflation is pro-cyclical as it tends to rise during booms and falls during periods of economic weakness. Measures of inflation are also coincident indicators. Consumption and consumer spending are also pro-cyclical and coincident.

These statistics cover how strong the labor market is and they include the following:

  • The Unemployment Rate
  • Level of Civilian Employment
  • Average Weekly Hours, Hourly Earnings, and Weekly Earnings
  • Labor Productivity

Unemployment and job creation has differed dramatically under different presidents.

These statistics are all updated monthly. The unemployment rate is a lagged, counter-cyclical statistic. The level of civilian employment measures how many people are working so it is pro-cyclic. Unlike the unemployment rate it is a coincident economic indicator.

The following graph illustrates the Unemployment Rate under the last four Presidential administrations.

Also, the rate of Job Creation under these same Presidential administrations proves interesting.

Production and Business Activity

These statistics cover how much businesses are producing and the level of new construction in the economy:

  • Industrial Production and Capacity Utilization
  • New Construction
  • New Private Housing and Vacancy Rates
  • Business Sales and Inventories
  • Manufacturers’ Shipments, Inventories, and Orders

These statistics are all updated monthly. Change in business inventories is an important leading economic indicator as they indicate changes in consumer demand. New construction including new home construction is another pro-cyclical leading indicator which is watched closely by investors. A slowdown in the housing market during a boom often indicates that a recession is coming, whereas a rise in the new housing market during a recession usually means that there are better times ahead.

This category includes both the prices consumers pay as well as the prices businesses pay for raw materials and include:

  • Producer Prices
  • Consumer Prices
  • Prices Received And Paid By Farmers

The Federal Reserve is much more concerned about inflation than deflation.

Consumer prices other than the cost of food and energy rose slightly in May after staying flat in April while the index of leading economic indicators barely rose in May after no change in April. Taken together, the data confirm once again that the U.S. economy is making a painfully slow exit out of recession.

These statistics are all updated monthly. These measures are all measures of changes in the price level and thus measure inflation. Inflation is pro-cyclical and a coincident economic indicator.

While the price of small items such as haircuts and boxes of cereal seems to be going up, the bigger driver of inflation is wages, and on that score, we are clearly in a deflationary environment. Most workers aren’t getting wage increases; rather, they’re getting laid off or working fewer hours. The Federal Reserve is much more concerned about inflation than deflation, but the Fed has to walk this tight wire right now.

The consumer price index (CPI) for May declined 0.2%, posting a 2.0% increase over the last 12 months, the U.S. Bureau of Labor Statistics (BLS) reported in mid-June. The CPI is a major indicator of inflation, and the recent figures show a striking lack of price pressure.

Fighting inflation is a matter of simply raising rates, but deflation is harder to fight. Generally, the government prints money and banks lend more and people spend more, but the dollar would be worth less, which would be bad for the economy and interest rates.

Money, Credit, and Security Markets

These statistics measure the amount of money in the economy as well as interest rates and include:

  • Money Stock (M1, M2, and M3)
  • Bank Credit at All Commercial Banks
  • Consumer Credit
  • Interest Rates and Bond Yields
  • Stock Prices and Yields

The following graphic illustrates the state of the Federal Budget Surplus/Deficit under the most recent four Presidential administrations.

These statistics are updated monthly. Nominal interest rates are influenced by inflation, so like inflation they tend to be pro-cyclical and a coincident economic indicator. Stock market returns are also pro-cyclical but they are a leading indicator of economic performance.

Economic indicators help us understand where we are and where we may be headed.

Federal Finance

These are measures of government spending and government deficits and debts:

  • Federal Receipts (Revenue)
  • Federal Outlays (Expenses)
  • Federal Debt

These statistics are updated annually. Governments generally try to stimulate the economy during recessions and to do so they increase spending without raising taxes. This causes both government spending and government debt to rise during a recession, so they are countercyclical economic indicators. They tend to be coincident to the business cycle.
International Trade
These are measure of how much the country is exporting and how much they are importing:

  • Industrial Production and Consumer Prices of Major Industrial Countries
  • U.S. International Trade In Goods and Services
  • U.S. International Transactions

When times are good people tend to spend more money on both domestic and imported goods. The level of exports tends not to change much during the business cycle. So the balance of trade (or net exports) is counter-cyclical as imports outweigh exports during boom periods. Measures of international trade tend to be coincident economic indicators.

While we cannot predict the future perfectly, economic indicators help us understand where we are and where we may be headed.