Economic indicators are used to predict future financial and economic trends. These may include unemployment rates, housing rates, inflation rates etc. There are primarily there types of indicators:
Lagging Indicators are those indicators that follow an event. It is generally used to confirm a pattern or indicate an event that is about to occur. The most popular and commonly used lagging indicator is unemployment. For example a high unemployment rate would indicate that the economy is doing poorly and that companies may anticipate a downturn in future. Other examples of lagging indicators include interest rates, labor costs etc. Lagging indicators usually indicate economic events and changes that follow a particular pattern or trend. They may be used to confirm long term trends but are not very effective in predicting them. (Investopedia)
Contemporaneous Indicators are economic events that occur within the same period of time. For example a rise in interest rates is usually associated or is contemporaneous with an increase in inflation. Or high personal income rates are contemporaneous with a strong economy.
Leading Indicators are those indicators that signal future events. The most common example of a leading indicator is bond yields. These can be used to anticipate and speculate trends in the stock market. Leading indicators may be used to predict changes in the economy but are not always accurate. An overview of four leading economic indicators is as follows:
Stock Market Returns
Production Work Week
1. Stock Market Returns
Stock market indicators are used to determine when to buy and sell stocks in either a bull or bear market. These indicators help investors determine the viability of purchasing stocks of a particular company as well as identify that company’s stock value or growth prospects. Common stock market indicators include market cap (total dollar value of all outstanding shares), Price/Earnings Ratio (valuation of a firm’s current share price compared to its per-share earnings), Return on Equity (measure of a company’s profitability), Dividend Yield (income produced by a share of stock) and Price To Book Ratio (comparing a stock’s market value to its book value). Stock market indicators are primarily used to project financial or economic trends in the stock market and can provide valuable insight about the national output i.e. the GDP and the economic growth of a country. (Superior Investor: Stock Market Resources)
2. Production Work Week
This indicator measures the length of the average work week of production workers in a manufacturing setting. This is an important indicator as it helps determine monthly industrial production as well as personal income of workers. It is also an important indicator of labor market conditions and can help track developments in areas which can have an impact on the economy. It can provide important information about major economic variables. For example it can help determine average earnings which help gauge or indicate potential inflation. It can also convey important information about the employment opportunities and unemployment levels of a particular economy.
3. Money Supply
Another common leading economic indicator is money supply. This indicator measures the total supply of money in circulation in a country’s economy at a particular point in time. Money supply is measured in many ways. The most widely used are M1, M2 and M3. M1 refers to the currency in circulation and back checking accounts. It includes all coins, publicly held currency, traveler’s checks, checking accounts and credit union accounts; M2 includes M1 plus any money in savings accounts, small time deposits, overnight repurchase agreements and non-institutional money market accounts.
M3 is M2 plus large time deposits, term repurchase agreements and institutional money market accounts. (Leading Economic Indicators: Money Supply TSC Glossary) The money supply indicator is useful in controlling inflation and to ensure that money demand remains stable. It also has a powerful effect on economic activity. An increase in money supply stimulates spending while a decrease results in decreased spending. Decreased spending may result in a decline in economic activity and can cause disinflation or deflation. Money supply is directly linked to inflation. If money supply is growing faster than the real GDP, inflation may result. (MindXpansion on Money Supply)
4. Inventory Changes
This indicator measures sales and inventories for the manufacturing, wholesale and retail sectors of the economy. It provides data on the rate of inventory accumulation which in turn helps determine the current pace of economic growth and may also help predict the future pace of economic growth. (Economic Indictors – Federal Reserve Bank of New York)
An example of an inventory change indicator is the Inventory to Sales ratio which measures the number of months it takes to deplete existing inventory. Inventory indicators provide important information about economic growth. For example if inventories are accumulating at a rapid pace, it may indicate a slowdown in economic growth in the near future as manufacturers may cut down production to ensure inventories are in line with sales. Similarly, if inventories are growing slowly or decreasing, it may indicate a growth in the economy in the near future and a pick up in production.
Information about Economic Indicators. Investopedia.com. 27th December 2006.
Money Supply Indicator. TCS Glossary. 1st January, 2007.
Money Supply Indicator. MindXpansion. 1st January, 2007.