The financial landscape can be complicated and seem like a puzzle; however, what if you could be ahead of the game and piece together the market's future before it occurs? This isn't speculation or guesswork, as this is understanding economic indicators. The ability to analyze economic indicators gives investors, traders, and business owners a competitive advantage and a more predictive vision for changes in the market, impending recessions, and strong growth periods.
This will focus on leading economic indicators—the data that is the magic bullet that changes direction first—and explore how to anticipate and exploit market trends.
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What Are Economic Indicators?
Economic indicators are data points or statistics about economic activity. They provide insight into the overall state and health of the economy. Economic indicators help market analysts and government economists track existing economic performance and predict where it might lead. They tell a story about economic health, which provides a reliable basis to make financial and investment decisions. Economic health directly connects to stock price activity, demand for commodities, relative values of currencies, and overall market trends.
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Three Categories of Indicators
To use these data points effectively, you'll need to first have some context. Economic indicators are broadly classified based on timing relative to the overall business cycle:
Leading Indicators (Our Focus): Leading Economic Indicators move first before the general economy moves, and they are the most effective tools (in point time) to predict market trends and/or lead investment decisions in either an expansion or contraction period.
Coincident Indicators: These indicators move with the economy, accurately indicating its current, real-time status (e.g., GDP (Gross Domestic Product)).
Lagging Indicators: Lagging indicators move after the economy has already changed and are confirmed indicators of trends that may already exist (e.g., Unemployment Rate).
For readers wanting to get a better sense of how macroeconomic factors like these relate to the valuation of assets, seek out the Fundamental Analysis in Stock Market.
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Top 5 Leading Economic Indicators
There are a few prominent indicators that stand out due to their accuracy in forecasting and value provided in impacting the future of the trend in question.
1. The Yield Curve (Interest Rate Spread)
What it is: The plot of yields on U.S. Treasury securities (bonds) against their respective time to maturity.
Why it leads: It is arguably the most accurate indicator of an upcoming economic recession. An inverted Yield Curve (short-term bond yield ? long-term bond yield) (i.e, 2-year yield > 10-year yield) has preceded almost every U.S. recession in history. The inverted yield curve tells consumers that investors expect lower interest rates and weaker growth in the future.
Market Trend Insight: A flattening or decline in the yield curve for an extended period of time would indicate to you that the future stock or market is at risk of decline.
2. Purchasing Managers’ Index (PMI)
What it Measures: A monthly survey of purchasing managers in both the manufacturing and services sectors on new orders, inventory levels, production, and employment.
Importance of Leading Indicator: Purchasing managers are often the first to experience demand fluctuation. When their buying patterns change, they are indicating an impending change in production and hiring trends before the government reports official statistics.
Key Threshold: A PMI reading above 50 indicates growth in the industry, while a reading below 50 indicates contraction. This is a key indicator to assess the overall health of the industrial economy.
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3. Initial Jobless Claims
What it Measures: The weekly number of people who have filed for unemployment benefits for the first time.
Importance of Leading Indicator: Prior to a major slowdown in the wider economy, many companies will slow hiring or begin layoffs. If there is a steep and prolonged rise in initial jobless claims, this means the unemployment rate will continue to increase, and the economy will continue to cool.
Market Trend Implication: Rapid spikes in Initial Jobless Claims can signal an impending recession and often precede volatile stock market trends.
4. Building Permits & Housing Starts
What it Measures: Government statistics tracking the number of permits issued for new housing construction, and the number of homes that construction has started.
Why it leads: The construction industry is very sensitive to interest rates and economic outlook. Developers only spend money on new projects (by taking out permits) when they are confident that there will be demand in the future and the cost of borrowing will be manageable.
Market Trend Insight: Decreasing housing permits can reflect decreasing consumer confidence and are a sign that housing and other market trends may be beginning to slow.
5. Consumer Confidence Index (CCI)
What it is: A survey that measures consumers' perceptions and expectations regarding current and future economic conditions, such as employment and income.
Why it leads: Consumer spending accounts for a huge part of the economy. When confidence decreases rapidly, consumers tend to cut back on discretionary spending, which creates an economic recession because businesses have less revenue.
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How to Use Indicators for Trend Analysis?
The value in these business indicators is not what the indicator is, but how to use leading economic indicators together for a composite view of the trends in the market.
1. Adopt the Composite View
Never rely on one indicator. All economic indicators have limitations and can produce false signals. The best way to use economic indicators is to look for confirmation across various, unrelated indicators (measures).
Seek Out Convergence: A genuine sign of a slowdown would be:
The Yield Curve is inverting.
The PMI has been dropping below 50 for several consecutive months.
Initial Jobless Claims are steadily rising.
A good way to simplify this process, though, is to look at the Conference Board Leading Economic Index (LEI) — which is a single index that incorporates the ten components (most of the above) to give you a single, statistically validated forecast of the direction of the economy in the U.S.
2. Focus on the Trend, Not the Number
One month of bad data is usually simply noise, but three to six months of degradation of a few key leading economic indicators is the signal. Instead of only the raw number, look at the trend and the direction of the shift in relation to the historical averages. For example, is the PMI dropping from 59 to 58 (still strong) or is it plunging from 52 to 47 (strong signal of contraction)?
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3. Correlate Indicators with Asset Classes
Different indicators have a more direct impact on some asset classes:
4. Integrate with Other Analysis
When trading and investing as an advanced practitioner, leading economic indicators provide macro context, but these analyses need to be developed by integrating micro analysis.
Fundamental Analysis: The macroeconomic outlook will impact company earnings — if the leading economic indicators suggest a projected recession, then you should be more wary in a Company’s Balance Sheet analysis, or in the assessment of the health of a stock.
Technical Analysis: You can follow the market's reaction to economic indicator releases through Top Technical Analysis Tools, like moving averages, Candlestick Patterns, for example -- a bad PMI reading can confirm a downtrend, signaled by a Moving Average Crossover Strategy.
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Conclusion
Once you understand how to track leading economic indicators, the guesswork has been removed from predicting market cycles. Understanding the differences in leading, coincident, and lagging data, and in particular just focusing your research on the key indicators you need for predictive analytics, such as illicit the Yield Curve, PMI, and Initial Jobless Claims gives you predictive coverage, you will then be able to compare whether the change evidences on fiscal trend after studying it from the economic indicator readings.
Remember again, the goal is not necessarily prediction at all -- it is intelligent anticipation; stock market even represents managed risk to achieve an outcome, so therefore, when observed through incremental pieces on the composite of these best economic indicators for stock market, you are able to situate continual adjustments to the trading portfolio or risk management techniques before they present for the majority to anticipate fiscal change to the overall economy.
When you are ready to step up your ability to analyze the markets, think about getting formal training with a Stock Market Course.
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