What Is an Economic Indicator?
An economic indicator is a piece of economic data, usually of macroeconomic scale, that is used by analysts to interpret current or future investment possibilities. These indicators also help to judge the overall health of an economy. While there are many different economic indicators, specific pieces of data released by the government and non-profit organizations have become widely followed. Such indicators include but aren't limited to theConsumer Price Index (CPI), gross domestic product (GDP), or unemployment figures.
Key Takeaways
- An economic indicator is a macroeconomic measurement used by analysts to understand current and future economic activity and opportunity.
- The most widely-used economic indicators come from data released by the government and non-profit organizations or universities.
- Indicators can be leading, which tend to precede trends; lagging, which confirm trends; or coincident, which occur simultaneously with economic conditions.
- Indicators can give investors insight as to how trades may play out, though unreliability of data and inconsistency of variables may make them less helpful.
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Types of Economic Indicators
Economic indicators can be divided into categories or groups. Most of these have a specific schedule for release, allowing investors to prepare for and plan on seeing information at certain times of the month and year.
Leading Indicators
Leading indicators, such as the yield curve, consumer durables, net business formations, and share prices, are used to predict the future movements of an economy. The numbers or data on these financial guideposts will move or change before the economy, thus their category's name. Consideration of the information from these indicators must be taken with a grain of salt, as they can be incorrect.
Investors are most often interested in leading indicators, as a correctly placed leading indicator can accurately predict future trends. Leading indicators may make broad economic assumptions. For example, many investors track forward-looking yield curves to project how future interest rates may dictate stock or bond performance. This analysis relies on historical data. Based on how investments performed the last time the yield curve was a certain way, some may assume those same investments may repeat their performance.
Coincident Indicators
Coincident indicators, which include such measures as GDP, employment levels, and retail sales, are seen with the occurrence of specific economic activities. This class of metrics shows the activity of a particular area or region. Many policymakers and economists follow this real-time data, as it provides the most insight into what is currently happening. These types of indicators also allow for policymakers to leverage real-time data without delay to make informed decisions.
Coincident indicators may be somewhat less helpful to investors, as the economic situation unfolds simultaneously. As opposed to a forecast or a prediction, a coincident indicator informs investors of what is actually happening in the present. Therefore coincident indicators may only be useful to those who can correctly interpret how economic conditions today (i.e. falling GDP) will impact future periods.
Lagging Indicators
Lagging indicators, such as gross national product (GNP), CPI, unemployment rates, and interest rates, are only seen after a specific economic activity occurs. As the name implies, these data sets show information after events have happened. Such trailing indicators are technical indicators that come after large economic shifts.
One drawback of lagging indicators is that a strategy developed in response to such indicators may arrive later than optimal. For example, by the time the Federal Reserve interprets CPI data and decides how best to enact monetary policy to stem inflation, the numbers it is observing can be slightly outdated. Though lagging indicators are still used by many governments and institutions, they also pose the risk of guiding incorrect decision-making due to erroneous assumptions about present-day economics.
Indicators provide signs along the road, but the best investors utilize many economic indicators, combining them to glean insight into patterns and verifications within multiple sets of data.
Interpreting Economic Indicators
An economicindicatoris only useful if one interprets it correctly. History has shown strong correlations betweeneconomic growth, as measured by GDP, andcorporate profit growth. However, determining whether a specific company may grow itsearnings based on one indicator of GDP is nearly impossible.
There is no denying the objective importance of interest rates, gross domestic product, existing home sales, or other indexes. The indicators reflect the cost of money, spending, investment, and the activity level of a major portion of the overall economy.
Like many other forms of financial or economic metrics, economic indicators hold tremendous value when compared across a period of time. For example, governments may observe how unemployment rates have fluctuated over the past five years. A single instance of unemployment rates doesn't yield much value; however, comparing it to prior periods allows analysts to better understand the issue as a whole.
In addition, many economic indicators have a benchmark set, whether by a government agency or other entity. Consider how the Federal Reserve's target rate of inflation is usually 2%. The Federal Reserve then enacts policies based on CPI measurements to achieve this target. Without this benchmark, analysts and policymakers wouldn't know what makes a indicator's value good or poor.
The Stock Market As an Indicator
Leading indicators forecast where an economy is likely headed. One of the top leading indicators is the stock market. Because stock prices factor in forward-looking performance, the market can indicate the economy’s direction if earnings estimates are accurate.
A strong market may suggest that earnings estimates are up, which may suggest overall economic activity is up. Conversely, a down market may indicate that company earnings are expected to suffer. However, there are limitations to the usefulness of the stock market as an indicator because the relationship between performance and estimates is not guaranteed.
Stocks are also subject to price manipulations caused by Wall Street traders and corporations. Manipulations can include inflating stock prices via high-volume trades, complexfinancial derivative strategies, and creative accounting principles, both legal and illegal. The stock market is also vulnerable to the emergence of “bubbles,” akin to false positives regarding the market’s direction.
If you're particularly interested in a specific economic indicator released monthly by the government, be aware that reports are often released on the same day of every month at the same time.
Advantages and Disadvantages of Economic Indicators
Pros of Economic Indicators
Economic indicators rely on data to substantiate predictions of what is to come in the future. When analyzed correctly, investors can capitalize on data to make successful trades or correctly assess future market conditions.
Economic indicators are often free and publicly accesible. In addition, economic indicators reported by governments often have a fixed cadence and steady form of measurement. This means you can usually rely on the method of how an indicator was calculated and the timing of when that indicator will be released.
Cons of Economic Indicators
A downside to economic indicators, particularly leading or coincident indicators, is that they rely on some degree of forecasting. While leading indicators are projections to the future, even coincident indicators rely on some assumptions. Such indicators do not always predict the future correctly, and the actions they recommend may not play out as expected.
Economic indicators, when boiled down to a single number, can also fail to capture complex realities. For example, consider all of the variables that contribute to the unemployment rate. This can include a wide range of influences, from macroeconomic conditions to minor details like weather patterns. As an indicator, the unemployment rate may not fully encapsulate all the factors contributing to an issue.
Finally, economic indicators are somewhat open to interpretation. Consider an example where inflation has dropped from 4.6% to 4.5%. Is this considered a good change, or should the drop have been larger? Economists and policymakers often debate the appropriate approach for interpreting economic data. Though the numbers may be concrete, different interpretations may lead to drastically divergent conclusions.
Economic Indicators Pros and Cons
Pros
May accurately forecast what is to come based on prevailing data
Often use publicly available information
May be calculated using the same process over and over, particularly when issued by governments
May be released on a fixed, predictable cadence
Cons
May not accurately predict the future
Rely on many assumptions, some of which may be unpredictable
Can be open for interpretation
Still require expertise to interpret and understand
What Is the Most Important Economic Indicator?
Every economist may come up with their own favorite economic indicator. For many, a country's GDP usually represents the best overall picture of a country's economic health. It combines the monetary value of every good and service produced in an economy for a certain period, and it considers household consumption, government purchases, and imports and exports.
Is Inflation an Economic Indicator?
Yes, inflation is a lagging indicator that is reported after a rise in prices has occurred. This type of economic indicator is helpful for government agencies to set public policy, as without this type of data, they would not know the direction of the economy. Therefore, while inflation and other lagging indicators are still useful to investors, they are especially critical for developing future policy responses.
What Are the Economic Indicators of a Strong Economy?
An economy may be strong if it has a robust amount of economic activity and job growth. This is measured by low unemployment, steady inflation, increases to construction, positive consumer index readings, and increasing GDP.
Do Traders Use Economic Indicators?
Traders and investment professionals may use economic indicators to predict how broad economic policy will impact their trades or investment strategy.
The Bottom Line
Economic indicators are leading, coincident, or lagging figures that indicate broad conditions. Economic indicators such as GDP, unemployment, inflation, or certain prices inform policymakers, individuals, companies, and investors of not only where the economy is today but perhaps where the economy may be headed. Economic indicators can be used to guide government policy or set investment strategies.
