[IMGCAP(1)]The economic recovery is top of mind in our national consciousness.
Listen to the news and you’re likely to hear some nugget of information about the state of our economy, with leading economic indicators provided as evidence. But what are economic indicators, and why do they seem to matter so much?
The nature of economic indicators
Understanding financial markets is a complex business that has yet to be perfected. Businesses, investment firms and everyday citizens all have a stake in how our economy performs. After all, the health of our economy can influence everything from the price of a gallon of milk to whether or not employers are hiring.
Essentially, an economic indicator is something identified as having some measurable relationship with economic productivity. Certain economic indicators are positively correlated with the economy. In a nutshell, when these indicators go up, the economy is up—and when they go down, the economy is down.
Similarly, there are economic indicators that have an inverse relationship with the economy. If these indicators increase (the unemployment rate, for example), then economic activity slows down. On the flip side, when these indicators taper, the economy tends to resurge.
Leading economic indicators are those that change before observable changes in the economy. Because these indicators are considered “predictive” of future events, they are carefully monitored and given more weight by economic analysts. Lagging economic indicators occur after the economy changes. While lagging economic indicators are not as helpful at predicting the future behavior of markets, they can help provide confirmation of a struggling, stagnant or growing economy.
Most economic indicators are measured and reported monthly. The Consumer Price Index, Producer Price Index and U.S. Import and Export Price Indexes are considered the three Principal Federal Economic Indicators that help the government measure and monitor the change in the prices of goods and services in the U.S. economy. Wall Street and savvy investors pay special attention to these and other economic indicators to look for trends that can help reveal opportunities and warnings in the stock market.
Consumer Price Index
According to the Bureau of Labor Statistics, the Consumer Price Index, or CPI, is defined as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”
It is an important measure used to determine inflation and the cost of living — how far your dollar goes to buy goods and services. The government uses CPI to help establish fiscal policies (affecting taxes and public spending) and monetary policies (affecting the supply of money).
Categories of goods measured for the CPI include food, energy and all items less food and energy. The index is further refined within each category, allowing analysts to uncover what may be driving costs and price fluctuations of certain items that are given more weight. For example, because Americans consume vast amounts of gasoline, eggs and milk, a price increase or decrease in these items is considered more significant than similar fluctuations in the price of luxury items, because nearly everyone’s pocketbook is affected.
Producer Price Index
Like the Consumer Price Index, the Producer Price Index, or PPI, is a weighted index that reflects wholesale prices for all goods produced in the United States, minus food and energy. PPI is useful in predicting CPI since wholesale pricing helps dictate the price of consumer goods. Investors can look for changes in PPI to help predict inflation.
U.S. Import and Export Price Indexes
Changes in the prices of nonmilitary goods and services traded between the U.S. and the rest of the world can help reveal the strength of our economy versus our trading partners. These indexes can help business leaders identify price trends and predict price inflation or deflation.
Productivity and Costs
Output per hour and unit labor costs are measured together to yield productivity statistics. This data helps investors assess overall business efficiency, which in turn affects profitability and, ultimately, shareholder value.
The measurement of real average hourly earnings can help analysts and investors try to figure out consumer buying power, particularly when these numbers are compared to the Consumer Price Index.
Issued monthly, The New Residential Construction Report contains valuable data obtained from nationwide surveys of homebuilders. Wall Street likes to report on housing starts and building permits, which are considered leading indicators. In general, a rise in new construction is indicative of growth in the economy at large.
Jobs matter to a healthy economy, so hiring and unemployment rates can reveal a great deal. Proactive investors can examine hiring in specific industries to look for opportunities.
The U.S. Census Bureau and the Bureau of Economic Analysis are two U.S. government agencies that monitor and report economic indicators. This information is in the public domain and is easily accessible online at their respective Web sites and www.economicindicators.gov. Applying the information is the tricky part. It’s not easy to accurately decipher the complex relationship between economic indicators and the stock market. For this reason, many investors rely on analysts who specialize in observing trends and making sense of market research on their behalf.
Rich Van Loan is a Financial Advisor and Chartered Retirement Planning Counselor with Ameriprise Financial Services, Inc. He can be reached at 617-337-3233 or via e-mail at Richard.firstname.lastname@example.org.
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