An economic indicator is a statistic or piece of data that offers insight into an economy. Analysts use economic indicators to gauge where an economic system is in the present moment, and where it might head next.
Governments use economic indicators as guideposts when assessing monetary or fiscal policies, and corporations use them to make business decisions. Individual investors can also look to these indicators as they shape their portfolios.
There are different types of economic indicators and understanding how they work can make it easier to interpret them.
What Is an Economic Indicator?
An economic indicator is typically a macroeconomic data point, statistic, or metric used to analyze the health of an individual economy or the global economy at large. Government agencies, universities, and independent organizations can collect and organize economic indicator data. In the United States, the Census Bureau, Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS) are some of the entities that aggregate economic indicator data.
Some of the most recognizable economic indicators examples include:
• Gross domestic product (GDP)
• Personal income and real earnings
• International trade in goods and services
• U.S. import and expert prices
• Consumer prices (as measured by the Consumer Price Index or CPI)
• New residential home sales
• New home construction
• Rental vacancy rates
• Home ownership rates
• Business inventories
• Unemployment rates
• Consumer confidence
Private organizations also regularly collect and share economic data investors and economists may use as indicators. Examples of these indicators include the Fear and Greed Index, existing home sales, and the index of leading economic indicators.
Together, these indicators can provide a comprehensive picture of the state of the economy and shine light on potential opportunities for investors.
How Economic Indicators Work
Economic indicators work by measuring a specific component of the economy over a set time period. An indicator may tell you what patterns are emerging in the economy — or confirm the presence of patterns already believed to be established. In that sense, these indicators can serve as a thermometer of sorts for gauging the temperature of the economic environment or where an economy is in a given economic cycle.
Economic indicators can not predict future economic or market movements with 100% accuracy. But they can be useful when attempting to identify signals about which way the economy (and the markets) might head next.
For example, an investor may study an economic indicator like consumer prices when gauging whether inflation is increasing or decreasing. If the signs point to a steady rise in prices, the investor might then adjust their portfolio to account for higher inflation. As prices rise, purchasing power declines but investors who are conscious of this economic indicator could take action to minimize negative side effects.
Recommended: How to Invest and Profit During Inflation
Types of Economic Indicators
Economic indicators are not all alike in terms of what they measure and how they do it. Different types of economic indicators can provide valuable information about the state of an economy. Broadly speaking, they can be grouped into one of three categories: Leading, lagging, or coincident.
Leading indicators are the closest thing you might get to a crystal ball when studying the markets. These indicators pinpoint changes in economic factors that may precede specific trends.
Examples of leading indicators include:
• Consumer confidence and sentiment
• Jobless claims
• Movements in the yield curve
• Stock market volatility
A leading indicator doesn’t guarantee that a particular trend will take shape, but it does suggest that conditions are ripe for it to do so.
Lagging indicators are the opposite of leading indicators. These economic indicators are backward-looking and highlight economic movements after the fact.
Examples of lagging indicators include:
• Gross national product (GNP)
• Unemployment rates
• Consumer prices
• Corporate profits
Analysts look at lagging indicators to determine whether an economic pattern has been established, though not whether that pattern is likely to continue.
Coincident indicators measure economic activity for a particular area or region. Examples of coincident indicators include:
• Retail sales
• Employment rates
• Real earnings
• Gross domestic product
These indicators reflect economic changes at the same time that they occur. So they can be useful for studying real-time trends or patterns.
Popular Economic Indicators
There are numerous economic indicators the economists, analysts, institutional and retail investors use to better understand the market and the direction in which the economy may move. The Census Bureau, for example, aggregates data for more than a dozen indicators. But investors tend to study some indicators more closely than others. Here are some of the most popular economic indicators and what they can tell you as an investor.
Gross Domestic Product
Gross domestic product represents the inflation-adjusted value of goods and services produced in the United States. This economic indicator offers a comprehensive view of the country’s economic activity and output. Specifically, gross domestic product can tell you:
• How fast an economy is growing
• Which industries are growing (or declining)
• How the economic activity of individual states compares
The Bureau of Economic Analysis estimates GDP for the country, individual states and for U.S. territories. The government uses GDP numbers to establish spending and tax policy, as well as monetary policy, at the federal levels. States also use gross domestic product numbers in financial decision-making.
Consumer Price Index
The Consumer Price Index or CPI measures the change in price of goods and services consumed by urban households. The types of goods and services the CPI tracks include:
• Food and beverages
• Medical care
CPI data comes from 75 urban areas throughout the country and approximately 23,000 retailers and service providers. This economic indicator is the most widely used tool for measuring inflation. According to the Bureau of Labor Statistics, which compiles the consumer price index, it’s a way to measure a government’s effectiveness in managing economic policy.
Producer Price Index
The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods, including:
• Natural gas and electricity
The Producer Price Index can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.
The unemployment rate is an economic indicator that tells you the number of people currently unemployed and looking for work. The BLS provides monthly updates on the unemployment rate and nonfarm payroll jobs. Together, the unemployment rate and the number of jobs added or lost each month can indicate the state of the economy.
Higher unemployment, for example, generally means that the economy isn’t creating enough jobs to meet the demand by job seekers. When the number of nonfarm payroll jobs added for the month exceeds expectations, on the other hand, that can send a positive signal that the economy is growing.
The Consumer Confidence Index can provide insight into future economic developments, based on how households are spending and saving money today. This indicator measures how households perceive the economy as a whole and how they view their own personal financial situations, based on the answers they provide to specific questions.
When the indicator is above 100, this suggests consumers have a confident economic outlook, which may make them more inclined to spend and less inclined to save. When the indicator is below 100, the mood is more pessimistic and consumers may begin to curb spending in favor of saving.
The Consumer Confidence Index is separate from the Consumer Sentiment Index, which is also used to gauge how Americans feel about the economy. This index also uses a survey format and can tell you how optimistic or pessimistic households are and what they perceive to be the biggest economic challenges at the moment.
Retail sales are one of the most popular economic indicators for judging consumer activity. This indicator measures retail trade from month to month. When retail sales are higher, consumers are spending more money. If more spending improves company profits, that could translate to greater investor confidence in those companies, which may drive higher stock prices.
On the other hand, when retail sales lag behind expectations the opposite can happen. When a holiday shopping season proves underwhelming, for example, that can shrink company profits and potentially cause stock prices to drop.
Census Bureau compiles data on housing starts. This economic indicator can tell you at a glance how many new home construction projects in a given month. This data is collected for single-family homes and multi-family units.
Housing starts can be useful as an economic indicator because they give you a sense of whether the economy is growing or shrinking. In an economic boom, it’s not uncommon to see high figures for new construction. If the boom goes bust, however, new home start activity may dry up.
It’s important to remember that housing starts strongly correlate to mortgage interest rates. If mortgage rates rise in reaction to a change in monetary policy, housing starts may falter, which makes this economic indicator more volatile than others.
Federal interest rates are an important economic indicator because of the way they’re used to shape monetary policy. The Federal Reserve makes adjustments to the federal funds rate — which is the rate at which commercial banks borrow from one another overnight–based on what’s happening with the economy overall. These adjustments then trickle down to the interest rates banks charge for loans or pay to savers.
For example, when inflation is rising or the economy is growing too quickly, the Fed may choose to raise interest rates. This can have a cooling effect, since borrowing automatically becomes more expensive. Savers can benefit, however, from earning higher rates on deposits.
On the other hand, the Fed may lower rates when the economy is sluggish to encourage borrowing and spending. Low rates make loans less expensive, potentially encouraging consumers to borrow for big-ticket items like homes, vehicles, or home improvements. Consumer spending and borrowing can help to stimulate the economy.
The stock market and the economy are not the same. But some analysts view stock price and trading volume as a leading indicator of economic activity. For example, investors look forward to earnings reports as an indicator of a company’s financial strength and health. They use this information about both individual companies and the markets as a whole to make strategic investment decisions.
If a single company’s earnings report is above or below expectations, that alone doesn’t necessarily suggest where the economy might be headed. But if numerous companies produce earnings reports that are similar, in terms of meeting or beating expectations, that could indicate an economic trend.
If multiple companies come in below earnings expectations, for example, that could hint at not only lower market returns but also a coming recession. On the other hand, if the majority of companies are beating earnings expectations by a mile, that could signal a thriving economy.
Economic indicators can provide a significant amount of insight into the economy and the trends that shape the markets. Having a basic understanding of the different types of economic indicators could give you an edge if you’re better able to anticipate market movements when you start investing.
You can use these indicators to help shape your investing strategy. One way to get started building a portfolio is by opening an online brokerage account on the SoFi Invest trading platform, which you can use to trade stocks, exchange-traded funds (ETFs), cryptocurrency and even IPOs.
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