You are on page 1of 8

Top Economic Indicators Explained

Nearly every day of the week we hear the media discuss recent economic news and how it will impact the trading day. Somehow the movements in the markets are always a result of positive or negative economic data that was released that morning. Negative news gets the most attention from the media because people love to be pessimistic. We feed on the terrible news and react irrationally when it is presented to us. A shrewd investor reads between the lines and beyond the negative headlines to find the underlying trends and data within the news. Here’s an example: the everyday individual will watch Good Morning America on Friday morning and hear that the Unemployment rate unexpectedly increased to 9.1%. Oh no! GMA brings in their employment specialist and he/she breaks down the data in a way that enthralls the viewer with numbers that are so terrible – we must be heading for a double dip recession! What the specialist left out was the reason the rate increased was because an abnormally high number of people joined the labor force, an indication that people are feeling more comfortable about the jobs market. Historically, people will abandon the job search during a recession, since jobs are scarce, and then re-enter as the economy improves and job openings appear. Therefore, although the rate hike to 9.1% is appalling, the increase in the labor force is a sound indication of improvement in the coming months. Mainstream media will tend to leave out the good news and capitalize on the bad – bad news sells! Never establish a stance on any piece of headline economic news until you have had a chance to dig into the underlying data and analyze it for yourself.

So what is an economic indicator?
An economic indicator can be any form of data that may or may not have an impact on the current or future movements in the economy and stock market. The economy can be viewed as a massive machine with numerous moving parts that work together to drive it. These parts can be extremely complex and difficult to understand. Knowing how they work together to power the machine is the key to harnessing its power and predicting its actions. An investor should know the current status of these moving parts and how that will impact the direction and speed of the machine. The raw data, out of context, will not be useful. These indicators can be categorized into three main groups: Leading, coincident and lagging. The leading indicators tend to predict future events in the economy, while coincident indicators will usually confirm current events or trends that are already under way. The final category, lagging indicators, tend to follow the movements in the economy. They should authenticate trends that have already begun.

       

Leading Indicators:
Jobless Claims
 
What is it?
The Initial Jobless claims report comes out every Thursday morning at 8:30. The report shows the number of people filing (for the first time) for jobless claims. The data is compiled by the U.S. Department of Labor and is seasonally adjusted based on certain times of the year having abnormal results due to holidays and the harvest season. Because the data comes out every week, it can sometimes be quite volatile week to week; therefore the release will always show the 4-week moving average. This average will show a more steady indication of the trend in jobless claims.

Why do investors care?
Investors love to follow Initial jobless claims because the data is so current. Coming out every week with the prior week’s data gives investors a close to real-time indication of the jobs market. Large movements in the report may give an indication for the employment data that will be released the following month. Most of all, along with all other employment data, the Initial Jobless Claims report gives an indication of the strength or weakness in the jobs market. They know that if more people are employed, then more people will have spending power. The more people spend, the healthier the economy, as personal consumption makes up two-thirds of our GDP.

Consumer Confidence
 
What is it?
The consumer confidence index comes out at 10:00 am on the last Tuesday of every month. The data is maintained by the Conference Board. Each month they send out a detailed survey to 5,000 random households around the country. The survey asks pertinent questions on the current economic conditions and on future expectations of economic conditions. The overall goal of the survey and ultimately the index is to gauge the attitudes of the everyday consumer in the country. Because the index is based on survey results from Joe Shmoes around the country, and not on hard statistical numbers, the data is highly subjective and distinct from all other economic indicators.

Why do Investors care?
Investors watch the consumer confidence index to gauge how the everyday American feels about the economy. Are people pessimistic or optimistic? The report can be meaningful to investors when they are unsure of the direction of the economy. If the survey results come back overwhelmingly positive, investors that were teetering on the edge of bearishness will be more inclined to stop selling and perhaps start buying equities. Because the everyday consumer drives the economy, this report is a good indication of how willing that consumer is to buy a new home or new car and stimulate economic growth. The subjectivity in the report comes from the notion that not everyone is an economist, and the little things like movements in gas prices will have an overweighting in the confidence of the consumer.

Existing Home Sales
 
What is it?
The Existing Home Sales report is released by the National Association of Realtors on the fourth week of every month at 8:30 am for the previous month. The data tracks the number of existing home sales that closed during the month. There are a few other pieces of data that come with the report, including median and average home sale prices by region and inventory levels (the amount of homes for sale in that month expressed through month’s supply, or the number of months it would take for all those homes to be sold at the current rate). This data is seasonally adjusted for different times of the year, as home sales tend to pick up in the summer months, and decrease in the cold winter months. The mortgage rate is usually included and the data includes condominiums.

Why do Investor’s care?
Existing home sales make up the majority of home sales in any given month (more than housing starts and new home sales). Because of the large volumes in this data release, investors can rely on the numbers to get a sense of the overall housing market. The housing market will tend to be more robust when the economy is expanding. A strong housing market will have a ripple effect on many other areas of the economy as new homeowners will be eager to buy new furniture, pave the driveway, hire a plumber, add some landscaping, or make any other number of purchases that will put money back into the economy. Existing home sales are a leading indicator because of this ripple effect leading to a strong economy and a strong stock market.

New Home Sales
 
What is it?
The New Home Sales report is released by the US Census Bureau toward the end of every month at 10:00 am for the previous month. A new home sale is tallied for every contract signing (not closing) or deposit for a new home. Keep in mind that the sale will be counted even if the home has not even been built yet, or is only partially built. Like other housing statistics, the New Home Sales report includes both volume and price indications. This data is seasonally adjusted for different times of the year, as home sales tend to pick up in the summer months, and decrease in the cold winter months.

Why do Investor’s care?
Investors follow new home sales as they do other housing statistics. The New Home sales data should be considered along with the others and not independently. Typically a contract is signed or a deposit is accepted one to two months before the actual closing date, therefore this report will have a more leading indication of the housing market than existing home sales. Like other housing indicators, the economic ripple effect is what makes the report so momentous. Consumers will have to be incredibly financially comfortable to consider buying a home. They will tend

to have a positive outlook of their future income levels in order to afford and maintain the new home (or at least they should!). Some say that new home sales have more of a significant role in the movement of the economy because they can include the construction and the sale of a home. This coverage area impacts the construction and building industry, furniture and other retailers, and all of the employees that help provide those services. Therefore significant movements in this report can have an impact on housing companies, construction companies, and miscellaneous retail companies.

Housing Starts
What is it?
The Housing Starts report is released by the US Census Bureau around the middle of every month at 8:30 am for the previous month. The release indicates the number of homes for which ground was broken to begin construction and for those that construction began on an existing foundation. Along with the starts data, the release also indicates how many building permits were applied for and approved in the month. The data released in this report is presented with both seasonally adjusted and nonseasonally adjusted figures. Also helpful is how the data is broken down by geographic region and by type of home (single-family or multi-family).

Why do Investor’s care?
Investors find housing starts and building permits to be incredibly predictive of future economic trends. Out of all the housing market indicators, the housing starts report with the building permits component is the most forward looking indicator of all other indicators. The builders around the country will have to be feeling quite confident in the real estate markets and overall economy to apply for and start building a new home to sell. Just like the other housing data, the ripple effect comes into play even more here. With several thousand starts happening every month, there is great potential for additional consumption and income flowing into the economy. Think of all the items that will need to be purchased to start a new home: appliances, lighting, lumber, landscaping, etc. The release of this report can have an impact on the stocks of home building companies, home furnishing companies, retail and appliance companies, as well as mortgage companies.

Coincident Indicators:
Retail Sales
 
What is it?
The Retail Sales report is released by the US Census Bureau and the US Dept of Commerce around the middle of every month at 8:30 am for the previous month. The data shows the total dollar value of goods sold in the month, and is broken down by different industries: Motor vehicle sales, apparel sales, electronics, gasoline, food, etc. Along with the extensive industry breakdown, there are also seasonally adjusted figures in the release. Be prepared, this release is notorious for significant revisions after the initial release.

Why do Investor’s care?
The retail sales data is one of the most telling coincident indicators. Because consumer spending makes up over 66% of GDP it is a significant indication of where the economy is heading. The more the consumer is spending on cars, trucks, gasoline, clothes, food, and books, the more profit and earnings large corporations will have. Strong retail sales are a blessing to stock market investors, but bond investors take caution. An increase in sales can also mean an increase in prices. An increase in prices can mean inflation, a phenomenon that will make bond investors cringe. Therefore the balance between economic growth and inflation is critically important to investors. Many times the retail sales data will be compared to the Consumer Price index to show the impact of inflation. Something important to note on this release is that the motor vehicle, gasoline, and food sales can be volatile and/or have seasonal fluctuations. Many investors will look at the data ex-autos, or ex-food and energy, as well as following monthly averages, year over year comparisons and seasonally adjust numbers to smooth out this volatility. Finally, this report can and will have a large impact on retail companies like Wal-Mart, Abercrombie & Fitch, Amazon.com, and 99 Cents Only Stores. An investor should look at companies like these and see how they are performing compared to their respective industries within the retail sales data.

Personal Income
What is it?
The Personal income and outlays report is released by the Bureau of Economic Analysis (BEA) towards the end of every month at 8:30 am for the previous month. As the title of the report signifies, there are two parts: personal income (dollar value received) and personal outlays (dollar value of expenditures). The personal income includes nearly all forms of income a person can have. Personal income, while primarily from the wages and salaries component, can also be derived from pensions, social security, dividends, interest, and rental income. The

personal outlays measurement includes consumption expenditures on durable goods, non-durable goods, and services. These figures are shown with and without inflation adjustments and are presented in month over month and year over year comparisons. Personal income does not include capital gains from sale of stocks.

Why do Investor’s care?
Personal income plays a significant role in how much people spend. As with retail sales, which come out earlier in the month, we know that consumer spending accounts for over 66% of GDP. With the average individual spending approximately 95 cents of every $1.00 received, this data is critical in determining how much spending will take place. If people are making more money, they will spend more money. Most importantly, inflation should be considered when analyzing the data. Keep in mind that even if consumers don’t spend their income dollars, it is still held at a bank in a savings account. The banks then use the money to lend and invest, indirectly pumping money back into the economy.

Industrial Production
 
What is it?
The Industrial Production report is released around the middle of every month by the Federal Reserve Board of Governors at 9:15 am for the previous month. The release consists of two items, Industrial Production and Capacity Utilization. Put simply, the report indicates the volume of goods being produced by factories, mines, and utilities. Along with these main groups, there is further breakdown into specific sectors like electronics, motor vehicles, or aircraft. The data is presented in month over month and year over year comparisons. The capacity utilization rate shows how much of the factory capacity is being utilized and is released at the same time and with the same industry and sector breakdowns.

Why do Investor’s care?
Industrial production, unlike consumer consumption, makes up a smaller portion (under 20%) of GDP. When analyzing the data, it is important to distinguish which areas were stronger/weaker than others. Investors benefit from the detailed breakdown of sectors and industry performance. Know that factories are producing more of one item and less of another can help investors in asset allocation and sector weighting decisions. The capacity utilization rate is more of a concern to bond investors and the Fed. A rate that is too high, usually anything over 85%, can be indicative of oncoming inflation. Therefore along with bond investors, the Fed watches this report closely to help guide them on setting interest rate policies.

Lagging Indicators:
PPI
 
What is it?
The Producer Price Index is released by the Bureau of Labor Statistics around the middle of every month at 8:30 am for the previous month. The PPI is an index of prices charged by wholesalers or producers. The data shows the change in price of a basket of goods produced by wholesalers month over month and year over year. Because of the extreme volatility in the food and energy component, the index is also presented without them. The PPI excluding food and energy is also called the core PPI and tends to show smoother month to month transitions. In addition to the break out of food and energy, the index shows the specific data for crude products, intermediate and finished goods. The data is released with seasonally and non-seasonally adjusted figures.

Why do Investor’s care?
An investor who tracks the movements in the PPI will be better positioned to react to future movements in the CPI. It is advantageous to know what is going on at the producer level, because soon enough the producers will have to pass on the inflated or deflated price pressures to the consumers. Secondarily, the PPI is a good indicator of the movements in commodity prices, as producers primarily deal with raw and unfinished goods. Bond and stock investors will be happy to see the PPI decline or post no change, as little to no inflation can mean low interest rates and greater profit potential for companies. Although the core PPI is less volatile than the headline PPI (because of the exclusion of food and energy) investors should still follow the complete/headline number. It is important to remember that food and energy play a significant role in the economy and should not be excluded to simply make the data easier to follow.

CPI
 
What is it?
The Consumer Price Index is released by the Bureau of Labor Statistics around the middle of the month at 8:30 am for the previous month. The CPI is presented in all the same ways as the PPI only it follows price movements at the consumer level instead of the producer level. The CPI follows the changes in price of a fixed basket of goods bought and used by the consumer. Examples of these products include milk, eggs, gasoline, computers, cars, apparel, and services such as a visit to the barber shop. The report can be broken down by industry group, service group, and commodity group as well as broken down by city or geographic regions. There is also a less-followed version of the CPI called chain CPI, which is a chain-weighted index. The difference here is that it follows a variable basket of goods instead of a fixed basket of goods. The benefit of the chained CPI is that it captures the changes in choices of products purchased by the consumer. Following the variable basket of goods takes into consideration the constant introduction of new and cheaper products into the markets that will impact the consumer’s buying decisions.

Why do Investor’s care?
Inflation is one of the most imperative economical phenomena for an investor to monitor. Although unpredictable at times, the mere uncertainty and fear of it can have a significant impact on stocks and bonds. Upon the release of the CPI data, markets will react accordingly. Because of the broad based utilization of the CPI data, investors should constantly be aware of the CPI and how it will affect things like mortgage rates, car loans, treasury rates, taxes, wages, and social security. The effect of inflation is best described by the $100 loan. If your friend asks to borrow $100 from you today and pay you back in one year with interest, how much interest do you charge him? Well, since we know inflation exists and that $100 today will not be worth as much as $100 a year from now, you should at least charge enough interest to make up for inflation. If inflation is currently at 2.5%, then you would have to charge him at least 2.5% interest on the $100 loan (perhaps you should charge him a percent or two more for the possible default risk and to make some $$ on the deal).

Employment Situation
What is it?
The Employment Situation report is released by the Bureau of Labor Statistics on the first Friday of every month at 8:30 am for the previous month. There are two parts to the report, the establishment survey and the household survey. The establishment survey reaches out to 440,000 businesses throughout the country and therefore has a much less margin of error. This extensive survey compiles statistics on payrolls, hours worked per week, and hourly earnings for non-farm payrolls. The household survey has somewhat of a larger diversification in its survey of over 60,000 households. This survey focuses on labor force statistics, employment statistics and unemployment statistics. The survey includes the self-employed, unpaid family workers, farm workers, and private household workers, all of which are unaccounted for in the Establishment survey. For the household survey, an unemployed individual is someone who is currently without a job, but is actively applying and capable of work. Both surveys capture only the data from a specific week in the previous month, usually the calendar week or pay period that contains the 12th day of the month. There are numerous other data points presented here as this is one of the most detailed economic reports available.

Why do Investor’s care?
Being one of the most headline newsworthy reports, investors pay close attention to the unemployment data. There is no other report that is as indicative to the healthiness of the jobs market. Everyone including the investors on Wall Street can understand the importance of having a job or looking for one, and therefore this report gets a lot of attention and can cause significant movements in the market. The reports extensive data points give investors copious amounts of economic indications for not only the jobs market, but the rest of the economy. Increasing wages can point to wage inflation and is closely watched by the Fed. Increases in the workweek will be positive to the stock market as it is an indication of increased productivity and a sign of future expansion in the economy. The payroll numbers are the most followed figures. With more people working and receiving a paycheck, the greater the possibility of them spending and stimulating the economy. In a stable and healthy economy, large increases in payrolls can be negative to investors as this could be a sign of oncoming inflation. Too many people employed will cause the demand for goods and services to spike, causing prices to spike, which will in turn cause inflation. Overall, the monthly employment numbers are a sure indication of the strength in the economy because of the economic ripple effect – more jobs = more earnings = more consumption = higher GDP.