Understanding the many different economic indicators may seem like a difficult task for most novice or intermediate investors. However, once you have a rather general understanding about what the indicators mean, using the data to make trade decisions on your personal investment portfolio will quickly become second nature.
The main economic indicators that will help an investor in making long-term investment decisions are the following:
Leading indicators are statistics that will eventually lead to economic turning points. An investor will take an interest in such indicators in order to determine whether they want to enter into positions, stay invested, or take defensive measures to protect against an expected future turn-around.
Indicators like building permits or average hours worked per week are both leading indicators and tell investors whether the future remains bright for the economy. Builders will only apply for permits, for example, if they have pre-sold enough homes that not applying could result in lost sales or the risk of losing their trades (workforce). Average hours worked per week are another good indicator because people will only be working overtime if the future demand remains strong; when average hours worked decrease, it is a good sign that things are slowing down.
Coincident indicators tend to mirror the economic and business activity of the day. Unemployment is one such indicator; as people are out of work, they are applying for unemployment benefits.
Lagging indicators help to confirm or refute potential discrepancies in leading and coincident indicators. For example, an increase in building permits may mean nothing if the Consumer Price Index (a lagging indicator) remains flat or is negative. (However, waiting on lagging indicators could result in opportunity losses and investors taking a passive, observer’s role in the investment community).
Knowing how to use each indicator is not an easy task, especially since particular stocks or market sectors will not be impacted by positive or negative news that impacts that particular sector. This happens for a variety of reasons, especially systemic reasons which means that the economy as a whole, or even the business cycle, will be discounted to the market’s “emotion,” which normally means the “emotion” in the market. This typically shows up as volatility.
Over the long term, however, the daily economic data will give clear indications as to the direction of the economy as a whole and where we are in the business cycle. Maintaining tabs on these indicators therefore makes it easier for investors to not only stay in tune with the trends of the overall economy and business cycle but can help in driving an investor’s optimistic or cautious view of the market in the long-term.