It is very common to hear economists or analysts in TV talking about the “health” of the economy and where the economy is headed. However, making a right prediction of an economy’s health is always not easy as it requires a thorough understanding and analysis of different economic indicators. By understanding the relevant key economic indicators, investors can make more informed financial decisions, which could lead to better long-term results.
An economic indicator is usually a piece of macroeconomic data that indicate the direction of the economy and each of them has a specific schedule for release. These indicators can be classified into three categories according to their usual timing in relation to the business cycle, namely leading indicators, lagging indicators, and coincident indicators.
Leading indicators considered predictors of economic trends as they often change before the economy as a whole change. Analysts always track leading indicators closely as they use these data to try to predict the next phases of the business cycle, which are critical when the economy is either coming out of a recession or heading into one. Besides, leading indicators also reveal which aspects of the economy are showing relative strength, which may help investors to do sector rotation investment. Last but not least, leading indicators also send clues to investors regarding inflationary or deflationary pressure, which could be one of the key factors for deciding the future interest rate trend. Examples of leading indicators include New Orders for Consumer Durables, Money Supply (M2), Building Permits, the Number of Manufacturing jobs as well as the stock market prices etc.
Lagging indicators, however, reflect the economy’s historical performance and usually change after the economy as a whole does. Generally, the lag is about a few quarters of a year. Despite lagging indicators do no typically tell us where the economy is headed, investors can use them to analyse the economy in retrospect or to confirm other economic data, which help to identify long-term trends as well as the effectiveness of policy directives. Examples of lagging indicators include the Dow Jones Transportation Average, Average Duration of Unemployment, the change in the Consumer Price Index for Services, Commercial and Industrial Loans, Average Prime Rate and the Gross National Product (GNP) et.
Coincident indicators change at approximately the same time as the business cycle. They occur in real time, thereby providing information to policymakers and economists about the current state of the economy. Coincident indicators are often used in conjunction with leading and trailing indicators in order to get a full picture of where the economy has been and how it is expected to change in the future. Examples of coincident indicators include Industrial Production, Gross Domestic Product (GDP), Personal Income and Retail Sales etc.
All in all, there are dozens of economic indicators announced every days or weeks, while tracking economic indicators could be a numbingly complex job for most people and investors are always confused on how to act. In fact, most economic indicators work best incorporated with other indicators. As such, we’ll later look at a few of the most relevant indicators that investor should pay attention to.