Economic Indicators For The Do-It-Yourself Investor
Economic indicators are some of the most valuable tools investors can place in their arsenals. Consistent in their release, wide in their scope and range, metrics such as the Consumer Price Index (CPI) and written reports like the "beige book" are free for all investors to inspect and analyze. Policymakers, most notably those at the Federal Reserve, use indicators to determine not only where the economy is going, but how fast it's getting there.
Admittedly, economic indicator reports are often dry and the data is raw. In other words, information needs to be put into context before it can be helpful in making any decisions regarding investments and asset allocation, but there is valuable information in those raw data releases. The various government and non-profit groups that conduct the surveys and release the reports do a very good job of collating and cohesively presenting what would be logistically impossible for any one investor do to on his or her own. Most indicators provide nationwide coverage and many have detailed industry breakdowns, both of which can be very useful to individual investors.
In this article, we'll touch on the most important aspects of economic indicators and how they relate to individual investors. (For more detailed information, see Economic Indicators To Know.)
What is an economic indicator?
In its simplest form, an indicator could be considered any piece of information that can help an investor decipher what is going on in the economy. The U.S. economy is essentially a living thing; at any given moment, there are billions of moving parts - some acting, others reacting. This simple truth makes predictions extremely difficult - they must always involve a large number of assumptions, no matter what resources are put to the task. But with the help of the wide range of economic indicators, investors are better able to gain a better understanding of various economic conditions.
There are also indexes for coincident indicators and lagging indicators, the components of each are based on whether they tend to rise during or after an economic expansion. (For related reading, see What are leading, lagging and coincident indicators? What are they for?)
Use in Tandem, Use in Context
Once an investor understands how various indicators are calculated and their relative strengths and limitations, several reports can be used in conjunction to make for more thorough decision-making. For example, in the area of employment, consider using data from several releases; by using the hours-worked data (from the Employment Cost Index) along with the Labor Report and non-farm payrolls, investors can get a fairly complete picture of the state of the labor markets. Are increasing retail sales figures being validated by increased personal expenditures? Are new factory orders leading to higher factory shipments and higher durable goods figures? Are higher wages showing up in higher personal income figures? The savvy investor will look up and down the supply chain to find validation of trends before acting on the results of any one indicator release. (For related reading, check out Surveying The Employment Report.)
Personalizing Your Research
Some people may prefer to understand a couple of specific indicators really well and use this expert knowledge to make investment plays based on their analyses. Others may wish to be a jack of all trades, understanding the basics of all the indicators without relying on any one too much. A retired couple living on a combination of pensions and long-term Treasury bonds should be looking for different things than a stock trader who rides the waves of the business cycle. Most investors fall in the middle, hoping for stock market returns to be steady and near long-term historical averages (about 8-10% per year).
Knowing what the expectations are for any individual release is helpful, as well as generally knowing what the macroeconomic forecast is believed to be at become important functions. Forecast numbers can be found at several public websites, such as Yahoo! Finance or MarketWatch. On the day a specific indicator release is made, there will be press releases from news wires such as the Associated Press and Reuters, which will present figures with key pieces highlighted. It is helpful to read a report on one of the newswires, which may parse the indicator data through the filters of analyst expectations, seasonality figures and year-over-year results. For those that use investment advisors, these advisors will probably analyze recently-released indicators in an upcoming newsletter or discuss them during upcoming meetings. (For articles about analyzing and using this data, see Trading On News Releases and A Top-Down Approach To Investing.)
Inflation Indicators - Keeping a Watchful Eye
Many investors, especially those who invest primarily in fixed-income securities, are concerned about inflation. Current inflation, how strong it is, and what it could be in the future are all vital in determining prevailing interest rates and investing strategies.
There are several indicators that focus on inflationary pressure. The most notable in this group are the Producer Price Index (PPI) and the Consumer Price Index (CPI). The PPI comes out first in any reporting month, so many investors will use the PPI to try and predict the upcoming CPI. There is a proven statistical relationship between the two, as economic theory suggests that if producers of goods are forced to pay more in production, some portion of the price increase will be passed on to consumers. Each index is derived independently, but both are released by theBureau of Labor Statistics. Other key inflationary indicators include the levels and growth rates of the money supply and the Employment Cost Index (ECI). (To learn more, read The Consumer Price Index: A Friend To Investors.)
Economic Output - Stock Investors Inquire Within
The gross domestic product (GDP) may be the most important indicator out there, especially to equity investors who are focused on corporate profit growth. Because GDP represents the sum of what our economy is producing, its growth rate is targeted to be in certain ranges; if the numbers start to fall outside those ranges, fear of inflation or recession will grow in the markets. To get ahead of this fear, many people will follow the monthly indicators that can shed some light on the quarterly GDP report. Capital goods shipments from the Factory Orders Report is used to calculate producers' durable equipment orders within the GDP report. Indicators such as retail sales and current account balances are also used in the computations of GDP, so their release helps to complete part of the economic puzzle prior to the quarterly GDP release. (For related reading, see The Importance Of Inflation And GDP and Understanding the Current Account In The Balance Of Payments.)
Other indicators that aren't part of the actual calculations for GDP are still valuable for their predictive abilities - metrics such as wholesale inventories, th "beige book", the Purchasing Managers' Index (PMI) and the Labor Report all shed light on how well our economy is functioning. With the assistance of all this monthly data, GDP estimates will begin to tighten up as the component data slowly gets released throughout the quarter; by the time the actual GDP report is released, there will be a general consensus of the figure. If the actual results deviate much from the estimates, the markets will move, often with high volatility. If the number falls right into the middle of the expected range, then the markets and investors can collectively pat themselves on the back and let prevailing investing trends continue.
Mark Your Calendar
Sometimes indicators take on a more valuable role because they contain very timely data. The Institute of Supply Management's PMI report, for instance, is typically released on the first business day of every month. As such, it is one of the first pieces of aggregate data available for the month just ended. While not as rich in detail as many of the indicators to follow, the category breakdowns are often picked apart for clues to things such as future Labor Report details (from the employment survey results) or wholesale inventories (inventory survey).
The relative order in which the indicators are presented does not change month to month, so investors may want to mark a few days on their monthly calendars to read up on the areas of the economy that might change how they think about their investments or time horizon. Overall, asset allocation decisions can fluctuate over time, and making such changes after a monthly review of macro indicators may be wise.
Conclusion
Benchmark pieces of economic indicator data arrive with no agenda or sales pitch. The data just is - and that is hard to find these days. By becoming knowledgeable about the whats and whys of the major economic indicators, investors can better understand the economy in which their dollars are invested, and be better prepared to revisit an investment thesis when the timing is right.
While there is no one "magic indicator" that can dictate whether to buy or sell, using economic indicator data in conjunction with standard asset and securities analysis can lead to smarter portfolio management for the do-it-yourself investor.
