Understanding economic indicators

Understanding economic indicators

Economic news reports significantly impact financial markets, and such news releases can send a ripple through the market. Economic indicators are usually microeconomic and macroeconomic market news and economic reports used by traders and investors to identify current or future investment opportunities or determine the overall health of the economy. News releases by a non-profit organization, companies, and the government have become the most widely followed economic indicators.

Economic statistics form the macro-fundamental indicators, while news releases form the micro-fundamental indicators. Macro-fundamentals such as Consumer price index (CPI), economic growth data, unemployment figures, gross domestic product (GDP), and interest rates tend to change gradually. They can establish a long-term trend in the market. That is why fundamental traders are mostly long-term traders.

On the other hand, micro-fundamentals such as company news releases and reports, board reshuffles, among others, create a robust trading momentum in the market immediately after release, which may last for a few days. This creates a short-term market trend. That said, essential market reports can reverse fundamental forecasts and start a new long-term trend.

Market reports are therefore crucial for both traders and investors because they can induce short-term volatility in the markets immediately after release, or defy the broader outlook of fundamental forecast and start a long-term trend.

Types of economic indicators

Economic indicators are of three types, namely:

• Leading indicators
• Lagging indicators
• Coincident indicators

They are macroeconomic metrics that reflect the current economic state within a country. They change with the business cycles, hence giving an almost real-time assessment of how the economy is performing. They include:

• Producer price index (PPI)
• Personal income reports
• Retail sales
• Employment levels, among others.

For example, the current productivity levels and demand for employees can be reflected in payroll data. Increased salaries would mean that firms are engaged in more business and can afford to pay good salaries to attract skilled workers due to increased revenues. Increased salaries would mean that workers have more cash to spend back into the economy, by allowing luxurious and flexible spending.  The net effect would be robust economic activities at the present moment. Such data will also show the segments of the economy that are the most vigorous and stable.

Leading indicators

As the name goes, they predict future changes in the economy before they happen. They can be used to predict a slow down or recess in the business cycle, depending on changes in data or numbers that change ahead of the economy. Policymakers and market observers use these metrics to predict essential changes that are about to happen in the marketplace. Though they may not always be accurate, leading indicators give valuable information concerning the future of the economy when looked at alongside other types of data. Examples of leading indicators are:

• Consumer expectation surveys
• Purchasing Manager Index(PMI)
• Gold and oil prices
• Yield curve
• labor market statistics
• stock indices
• Net business formations
• Jobless claims

For example, economists will forecast the country’s gross domestic product (GDP) by observing the Purchasing Manager Index (PMI) closely. Another leading indicator that is perceived to be the most accurate is the Consumer Confidence Index (CCI). It is calculated from a survey of the perceptions and attitudes that consumers have about the economy.

Different investors rely on leading indicators to make investment decisions. Jobless claims are one of the leading indicators that investors have an interest in. Rising jobless claims point to a weakening economy, which can impact the financial market negatively. Fewer jobless claims are an indicator of growth in the business sector, which is good news for stock market investors.

Lagging indicators

Lagging indicators move or change direction after changes in the economy have occurred. They become in handy when confirming trends or changes in patterns. In financial markets, lagging technical indicators trails the price action. Traders use then to generate buy/sell signals, or to confirm how strong a trend is before making a trading decision. There are three types of lagging indicators.

• Technical lagging indicators: they trail behind the current price of an underlying asset. That means the indicator occurs when the price movement has already happened. A good example is moving average crossover. A short-term moving average crossing above a long-term moving average indicates an increase in momentum in the market. Traders rely on such an indicator as confirmation to place buy orders. For example, a 50-period moving average crossing above a 200-period moving average.
• Economic lagging indicators: unemployment rate, company profits, interest rates, the balance of trade, Gross National Product(GNP) among others are economic lagging indicators that change in reaction to movements in the market.
• Business lagging indicators: in business, lagging indicators are key performance indicators. They reflect past performance, as seen in financial statements and operational data. They show the impact that the business strategy employed and the management decisions made on the performance of the business.

As you can see, both leading, coincidental, and lagging indicators are essential to traders and investors. They help them so see what is happening in the overall economy, as well as inside the company where they have an investment interest in, hence helping them make better-informed decisions. As a trader or investor, combining technical analysis with a better understanding of economic indicators will go a long way in helping you devise a better trading strategy.