Economic Indicators That Help Predict Market Trends

Economists typically group macroeconomic statistics under one of three headings—leading, lagging, or coincident. That means they're viewed through the windshield, the rear-view mirror, or the side window.

Coincident and lagging indicators provide investors with some confirmation of where the economy is and where it has been recently, giving some indication of where it might be heading.

All of this information is made freely available by the government agencies and other organizations that compile, analyze, and report the data. It also helps policymakers determine what they need to do to keep the economy stable or encourage it in a better direction.

Market Indexes

In order for an economic indicator to have predictive value for investors, it must be current, it must be forward-looking, and it must discount current values according to future expectations. Meaningful statistics about the direction of the economy start with the major market indexes and the information they provide about:

• Stock and stock futures markets
• Bond and mortgage interest rates, and the yield curve
• Foreign exchange rates
• Commodity prices, especially gold, other metals, grains, and oil

Although these measures are crucial to investors, they are not generally regarded as economic indicators per se. This is because they do not look very far into the future—a few weeks or months at most.

Charting the history of indexes over time puts them in context and gives them meaning. For instance, it is not terribly useful to know that it costs $1.26 to purchase one British pound, but it may be useful to know that the pound is trading at a five-year high or a five-year low against the dollar.

Indicative Weekly Data Reports

The Unemployment Insurance Weekly Claims Report is released weekly by the Department of Labor. In a weakening economy, unemployment filings trend upward. They are generally analyzed as a four-week moving average (MA), to smooth out week-to-week variance. Increasing claims suggest a weakening economy.

This report is viewed as having a built-in bias because self-employed people, part-timers, and contract employees who lose their jobs do not qualify for benefits and thus are not counted.

Money Supply

Money supply, tracked and published by the Federal Reserve, is a relatively abstract technical calculation. It adds up how much cash is sloshing around in the economy.

In a digital world in which vast sums of money can be transmitted across the globe in an instant, this indicator has lost much of its importance.

Indicative Monthly Data Reports

The Monthly New Residential Construction report, commonly referred to as housing starts, is released by the Census Bureau and the Department of Housing and Urban Development (HUD). The report breaks out the number of building permits issued, housing starts, and housing completions.

This is considered an important leading indicator because construction activity tends to pick up early in an expansion phase of the business cycle.

Existing Home Sales

The Existing-Home Sales news release is released by the National Association of Realtors. Whereas the housing starts report focuses on supply, this report focuses on demand.

Together, the New Residential Construction and Existing Home Sales reports are used to assess the overall health of the housing sector.

The data contained in this report are typically two months old owing to the length of time involved in closing home sales. It is useful in predicting consumer spending. However, it must be considered in light of current factors such as the direction of mortgage interest rates and the seasonal nature of the real estate business.

Consumer Confidence

The Consumer Confidence Index (CCI) is released by the Conference Board, a nonprofit business research group.

This is one of a handful of reports that measure and track the perceptions and attitudes of consumers, and how they regard their personal financial wellbeing.

The results are inexact and imprecise, but the Consumer Confidence Index has proved surprisingly accurate in projecting consumer spending, which typically accounts for around two-thirds of U.S. GDP.

Other Important Indicators

The Manufacturing Business Outlook Survey is released by the Philadelphia Federal Reserve and is based on a survey of purchasing managers at 5,000 manufacturing companies in Pennsylvania, Delaware, and New Jersey. The survey collects "better", "same", or "worse" readings on a host of questions about the prices and availability of the supplies they buy routinely.

Its limitations—a small sample size, limited geography, and a manufacturing focus—do not prevent it from accurately gauging the key Purchasing Managers Index (PMI) report it precedes. The month-to-month variance in the readings is due in part to the small sample size.

Purchasing Managers Index

The Purchasing Managers Index (PMI) is released by the Institute for Supply Management, formerly the National Association of Purchasing Managers.

Despite its small sample size and focus on manufacturing, Wall Street watches it closely because it has historically been reliable in predicting growth in gross domestic product (GDP).

Mutual Fund Flows

The Estimated Long-Term Mutual Fund Flows report is issued monthly by the Investment Company Institute. This indicator aggregates the amounts of cash flowing into stocks, bonds, and money market mutual funds.

This report is not widely used for several reasons. It omits individual stock purchases and sales and does not differentiate between systematic investing (such as 401(k) contributions) and market timing actions.

It is also a contrarian indicator in that many individual investors react to events by, in effect, buying high and selling low. Money market fund flow is reported separately by the Federal Reserve.

Industrial and Manufacturing Reports

The Monthly Report on Durable Goods Manufacturers' Shipments, Inventories, and Orders, better known as the Durable Goods Report (DGR), is released by the Census Bureau. It surveys manufacturers of goods that have a life expectancy of more than three years.

Durable purchases by businesses signify capacity expansion. More sales at retail suggest rising consumer confidence. High month-to-month volatility requires the use of moving averages and year-over-year comparisons to identify pivot points in the economy.

Factory Orders

The Factory Orders Report, also from the Census Bureau, is more detailed and less timely than the Durable Goods Report. Its shortcoming is that it fails to account for price changes that can greatly affect inventories during both inflationary and deflationary times.

The report contains data for the two months before its release, making it another "leading from the rear" indicator.

The Beige Book

The "Beige Book" (officially the "Summary of Commentary on Current Economic Conditions by the Federal Reserve") is released eight times per year by the Federal Reserve. It includes a collection of discussions from each of the 12 Fed districts, along with a summary statement, all of which are presented in the non-committal, measured tones known as "Fed speak."

Analysts and investors attempt to decipher the meaning of the report, which is much like reading tea leaves. The report foreshadows Federal Open Market Committee (FOMC) actions at the following meeting, although the bond market predicts these actions with a statistical measure that is virtually foolproof.

The Bottom Line

Leading economic indicators can give investors a sense of where the economy is headed so that they can adjust their investment strategies to fit future conditions. They are most useful when they're tracked over time so that the larger trend can be seen.

Indicators are not perfect and can always be upended by unexpected events. Even so, watching which way the economy is moving and adjusting your investment choices accordingly makes sense.