Building a bit on the three-part ‘Macroeconomic Fundamentals Explained’ series we have published in July this year, I want to go a bit deeper into economic indicators that are relevant to investors.
Economic indicators serve as invaluable tools for investors to include in their arsenal. These metrics, like the Consumer Price Index (CPI) and written reports such as the Beige Book, are consistently released and offer a broad range of information. All investors have access to inspect and analyze these indicators freely. Policymakers, particularly those at the Federal Reserve, rely on these indicators not only to gauge the economy’s direction but also its pace of growth.
While it’s crucial for investors to familiarize themselves with economic indicators, it’s worth acknowledging that the reports can often be dry, and the data can be raw. In other words, to make informed decisions about investments and asset allocation, it is essential to contextualize the information. Nevertheless, valuable insights can be gleaned from these raw data releases. The various government and nonprofit groups responsible for conducting surveys and releasing reports effectively collate and present information that would be practically impossible for any individual investor to do alone. Most indicators provide nationwide coverage and detailed industry breakdowns, both of which can prove highly beneficial to individual investors.
What Constitutes an Economic Indicator?
In its most basic form, an economic indicator can be defined as any piece of information that aids investors in interpreting the state of the economy. The U.S. economy is akin to a complex organism with billions of dynamic elements, some in action and others reacting to various stimuli. Due to this inherent complexity, making predictions about the economy is extremely challenging and necessitates numerous assumptions, regardless of the available resources. However, by leveraging a diverse array of economic indicators, investors can enhance their comprehension of different economic conditions. These indicators also include indexes for coincident indicators and lagging indicators, each characterized by whether they tend to rise during or after an economic expansion.
Using Indicators in Combination and Context
Once investors have a grasp of how different indicators are computed and their relative strengths and limitations, they can combine multiple reports to make more comprehensive decisions. For instance, in the realm of employment, one can leverage data from various releases. By integrating information from hours-worked data (via the Employment Cost Index), Employment Situation Summary, and nonfarm payrolls, a more complete understanding of the labor market’s condition can be achieved.
Furthermore, it’s essential to validate increasing retail sales figures with a rise in personal expenditures. Similarly, investors should check if new factory orders are translating into higher factory shipments and durable goods figures. Additionally, higher wages should ideally be reflected in higher personal income figures. Smart investors explore the supply chain from top to bottom to corroborate trends before making decisions based solely on one indicator release.
Different individuals may adopt distinct approaches to using economic indicators. Some may choose to deeply understand a few specific indicators and make investment decisions based on their expert analyses. Others may prefer a more general approach, familiarizing themselves with the basics of various indicators without heavily relying on any single one. For example, a retired couple relying on pensions and long-term Treasury bonds will have different priorities compared to a stock trader navigating the business cycle’s fluctuations. Many investors fall somewhere in between, seeking steady stock market returns close to long-term historical averages (around 8% to 10% per year).
Understanding expectations for each indicator release and having a grasp of macroeconomic forecasts is beneficial. Forecast figures can be found on public websites such as Yahoo! Finance or Forexfactory. On the day of a specific indicator release, press releases from newswires like the Associated Press and Reuters will present key figures with important highlights.
Reading a report on one of these newswires can be helpful, as it often filters the indicator data through analyst expectations, seasonal patterns, and year-over-year comparisons.
Monitoring Inflation Indicators
Inflation is a significant concern for many investors, particularly those heavily invested in fixed-income securities. Understanding the current inflation rate, its strength, and its potential future impact is crucial for determining interest rates and devising effective investment strategies. Several indicators focus on measuring inflationary pressure, with the Producer Price Index (PPI) and the Consumer Price Index (CPI) being the most prominent ones. Many investors use the PPI to predict upcoming CPI trends, as there is a statistical relationship between the two. Economic theory suggests that if producers face increased production costs, some of those cost increases will be passed on to consumers. While both indices are independently derived, the Bureau of Labor Statistics (BLS) releases both of them. Additionally, key inflationary indicators include the money supply levels and growth rates, as well as the Employment Cost Index (ECI).
Economic Output Insights for Stock Investors
The gross domestic product (GDP) is arguably the most critical economic indicator, especially for equity investors focused on corporate profit growth. As the sum of all goods and services produced within the economy, GDP’s growth rate is targeted to fall within specific ranges. Any deviations from these ranges can trigger fear of inflation or recession in the markets. To anticipate such fluctuations, many investors closely follow monthly indicators that shed light on the quarterly GDP report.
For instance, capital goods shipments from the Factory Orders Report are used to calculate producers’ durable equipment orders within the GDP report. Other indicators, like retail sales and current account balances, also contribute to the GDP computations, providing insights into the economic puzzle before the quarterly GDP report is released.
Although some indicators are not directly part of the GDP calculations, they still hold predictive value. Metrics such as wholesale inventories, the Beige Book, the Purchasing Managers’ Index (PMI), and the labor report offer valuable information about the overall health of the economy. As these monthly data points gradually emerge throughout the quarter, GDP estimates become more accurate. Consequently, when the actual GDP report is published, it often confirms the general consensus. Significant deviations from the estimates can cause high market volatility, while results within the expected range allow prevailing investment trends to continue.
Mark Your Calendar
Some indicators gain added significance due to their timely data releases and instant effects on the markets. For instance, the Institute for Supply Management’s PMI report is typically published on the first business day of each month, making it one of the first pieces of aggregate data available for the previous month. Though not as detailed as other indicators, its category breakdowns are scrutinized for insights into future labor report details and wholesale inventories.
Investors may find it useful to mark certain days on their monthly calendars to review specific economic areas that might influence their investment decisions or time horizons, or to remember when to not trade and avoid volatility. Overall, asset allocation decisions can fluctuate over time, and periodic adjustments based on macro indicators can be prudent.
Economic indicators offer objective and agenda-free data that can be hard to come by in today’s world. By understanding major economic indicators and their implications, investors can gain valuable insights into the market and the broader economy in which they invest. This knowledge also equips them to revisit investment theses at opportune times. Although there’s no magical indicator to dictate buy or sell decisions, integrating economic indicator data with standard asset and securities analysis can lead to more informed portfolio management for both professional asset managers and retail investors.