Rick Welch: Dollars and $ense

What are Economic Indicators?

To be a good investor requires an understanding of how changes in our economy can affect the financial markets. Think of the economy as a cloud, with no predetermined shape, which is constantly moving and shifting. This tendency of a cloud (or economy) to constantly change requires that we examine it from a variety of angles and multiple perspectives. Some angles or perspectives are more relevant than others in providing us with an accurate picture of an economy as it moves through different business cycles.

Indicators are differentiated by the timing (past, present or future) of the information they provide. A lagging indicator reports a change in the economy that has already occurred. A coincident indicator reports a present condition. Leading indicators often suggest a future trend and provide the best clues for the investor. Analyzing a selection of carefully chosen economic and investment indicators is one means of building an actionable picture of a changing economy. The question that most investors often struggle with is what selection of indicators will give me the best picture of the changing economy? In the paragraphs that follow we describe some of the indicators that we regularly analyze.

As consumer consumption accounts for 70% of annual GDP, we look to the monthly Consumer Confidence Index, published by the Conference Board (www.conference-board.org), which Index is a leading indicator that gives clues about future consumer spending attitudes. Employment data regularly moves the markets and, as such, we follow the monthly Nonfarm Payroll Employment Report and the monthly Unemployment Rate (both are found at www.bls.gov). Both of these employment measures are coincident indicators. Each month the Philadelphia Federal Reserve (www.philadelphiafed.org) publishes a Business Outlook Survey which describes present conditions and expected conditions six months in the future. It is a very interesting and easy to read report that is highly regarded. The monthly Durable Goods (www.census.gov) report provides capital investment data for consumers and businesses. Both the Fed survey and Durable Goods Report are leading indicators.

Monthly International Trade Balance (www.census.gov) data shows export and import volumes and the trade deficit (exports minus imports) which currently stands at $40.3 billion. A widening trade gap can act as a drag on domestic economy growth. The Big Mac Index (which we do not follow) compares the relative cost of purchasing the famous McDonald’s sandwich in different currencies with the applicable rate of exchange. One of the recent drivers of our improving economy has been the housing sector. Two leading indicators for this sector are Housing Starts and New Home Sales (both are found at www.census.gov). An important investment indicator is the CBOE Volatility Index or VIX which is a relative measure of the cost of buying options on the S&P 500 Index one month in the future. In general terms, an increase in volatility often translates into falling stock prices. A VIX reading under 20.00 denotes a period of relative calm.

This article is just a starting point. Talk to your investment advisor and find out what indicators he/she follows. Understanding which indicators they think are important will give you better insight into their investing philosophy and strategy. Compile your own chart using green for improving data and red for deteriorating data. After a year go back and see how changes in the data corresponded with changes in the financial markets.

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