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What Are The Best Leading Economic Indicators

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by Gavin in Blog
June 28, 2020 0 comments

Novice investors often fall into the trap of buying falling stocks because they’re ‘cheap’.

Unfortunately, they rarely ask themselves why they’re cheap in the first place.

One of the core tenets of the stock market is that whenever you’re buying a stock, you’re not just buying a piece of paper.

What you’re actually doing is buying a share in a business – a business with revenues and expenses.

If, over time, revenue growth outpaces expenses growth, the price of the stock will rise.

This can be impacted in the short term by investor psychology but over long enough periods, the price of a stock will be related to the performance of its fundamentals.

One of the biggest impacts on business growth and therefore share prices, is the state of the economy.

As the economy grows, businesses generate more profits, pushing up stock market prices.

As the economy shrinks, business profits diminish and they cut back on investment and expenses which hurts other businesses as well, pushing down stock market prices.

As a trader, it’s important to keep an eye on the performance of the economy to give you an indication of the direction that the stock market may follow.

There are three main types of economic indicators – leading, lagging or coincident.

This article will list out the best leading indicators which are forward-looking data points of where the economy may be heading.

Leading Economic Indicators

Employment

As an economy begins to weaken, the number of unemployment filings will start to move upwards.

Likewise, if the economy accelerates, unemployment filings will decrease however there is usually a lower-bound floor as not everyone can or will participate in unemployment, or the working population is increasing at the same pace as new jobs are being created.

It’s also worth bearing in mind that different jurisdictions may or may not allow self-employed, part-time and casual employees to claim unemployment so this may skew results.

Most governments publish unemployment filings online, in the US this can be found in the Jobless Claims Report released weekly by the Department of Labor.

Residential Construction

Residential construction is a big driver of many economies.

From building materials, through to trades and services and even the provision of credit, a lot of business rely on a robust construction sector.

As economic conditions improve, individuals and families are more willing to buy properties, pushing up demand and therefore construction.

Reports on residential construction, referred to as ‘housing starts’, is usually released monthly by government census or statistics bureaus. In the US the Census Bureau and the Department of Housing and Urban Development release it.

Home Sales

The previously mentioned ‘housing starts’ report can be seen as a focus on supply as it tracks the number of new dwellings being constructed.

By combining it with a demand view, such as a home sales report, an investor can get a full picture of the overall health of the housing construction sector.

These reports are typically generated by realtor organisations and usually contain sales data from one to two months ago due to the time it takes for a home sale to be processed.

Consumer Sentiment

In most developed economies, consumer spending can sometimes account for up to 60-70% of an economy’s output.

That’s why it pays to keep a close eye on whether consumers are feeling optimistic and therefore more likely to spend in the future, or whether they are likely to curb spending in light of growing pessimism about job prospects and the economy.

One such report in the U.S. is the Consumer Confidence Index which surveys consumers to understand their perceptions and attitudes.

Manufacturing Business Purchases

Despite manufacturing making up a small percentage of overall GDP, it has long been a reliable predictor of growth in GDP.

To get an understanding of how manufacturing is performing, in the U.S., the Institute of Supply Management releases a key manufacturing business purchases report called the Purchasing Managers Index.

Industrial Reports

The health of heavy industry, being manufacturers of goods with a greater than three-year life expectancy, can help provide an indication of whether businesses are trying to expand their capacity.

Further, analysing sales at retail can also provide a proxy for consumer confidence.

The Census Bureau produces data on the heavy industry as part of its Durable Goods Report.

Reserve Bank Reports

The final lead economic indicator this article will cover are the reports produced by Reserve Banks.

Since they are government agencies focused on keeping economies within an agreed inflation range, they get to consume a lot of data from a variety of sources to get a great birds-eye view of the health of the economy.

In the US, one such report is the Summary of Commentary on Current Economic Conditions, sometimes referred to as the ‘Beige Book’.

Released by the Federal Reserve eight times per year, it is watched closely by investors, particularly in the bond market where governments tend to intervene the most through interest rate changes, repos and quantitative easing.

Conclusion

While no indicator will ever give you a precise forecast of the future, when these economic indicators are taken together, investors can get a picture for how the economy may behave over the coming months.

Unfortunately, black swan events and adverse shocks can come at any time and render any economic forecast moot.

However, at least knowing the anticipated trend of the economy can help investors in knowing when to adjust their level of exposure and risk.

Using the above economic indicators can give a pretty good feel for whether the economy is more likely to improve or suffer a slump.

Trade safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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