What is an economic indicator?
An economic indicator is a metric that can give you insight into the economic performance of a particular country. Companies use economic indicators for internal purposes. But people also use these metrics on a macroeconomic level to gauge the health of the overall economy.
On a large scale, economic indicators help economists and government officials craft policy. And on a smaller scale, these indicators help individual consumers and investors make decisions about their money.
Economic indicators generally fall into three categories: leading, lagging and coincident.
- A leading indicator is one that can be used to predict changes in other economic metrics. Economists and policymakers use leading indicators for forecasting and for creating fiscal and monetary policy. Investors and businesses also find them useful. Examples of leading indicators include durable goods orders, the stock market, the yield curve and more.
- Lagging indicators show an economic trend that has already happened. In other words, they can't be used to predict future trends. People use these to confirm trends and identify turning points in the economy. Examples of lagging indicators include the unemployment rate, the consumer price index (CPI) and others.
- Finally, a coincident indicator is one that provides useful data about an economic event that's currently happening. Economists, policymakers and other decision-makers use these frequently. These indicators provide the closest thing to real-time data. Coincident economic indicators include the gross domestic product (GDP), retail sales and employment levels.
Economic indicators you should know as an investor
There are many economic indicators that economists, policymakers, investors and business owners can use to gauge the financial health of the economy. However, there are a handful of must-know economic indicators that are most useful and that all investors should understand.
GDP
The gross domestic product (GDP) of a nation measures the value of all goods and services produced in the country during a particular period of time. GDP is generally used as a scorecard of a country's overall economic health.
The U.S. Department of Commerce reports the GDP quarterly. In general, an increase in the GDP is considered a positive trend. A decline is seen as negative.
GDP is reported in both nominal and real numbers. The nominal (or standard) GDP doesn't necessarily reflect the actual growth of the economy, since it doesn't account for inflation. The real GDP subtracts the inflation rate from the GDP. And this gives a more accurate picture.
Even more important than calculating the GDP is measuring the GDP growth rate. This growth rate shows us how much the economy has grown — or shrunk — since the last reporting period.
For example, in 2020, the U.S. GDP was $20.937 trillion, according to data from the World Bank. Without context, it's difficult to know exactly what that means. But when we look at the GDP from the previous year, we see the economy actually had negative growth, since the 2019 GDP was $21.433 trillion.
Unemployment rate
Each month, the U.S. Bureau of Labor Statistics (BLM) releases data on the total nonfarm employment in the country. It also reports the unemployment rate, or the percentage of workers who are currently unemployed and are actively seeking and available to work. The unemployment rate excludes workers who are not actively seeking work, except for those who are unemployed and want a job but aren't currently seeking one because they believe no jobs are available.
Employment data is one of the most important metrics in the economy. It's also one of the most widely discussed by economists, policymakers, the media and individual consumers. It affects individuals, businesses, the stock market and decisions by policymakers. In general, a low unemployment rate shows us that the economy is booming and that because businesses are hiring, they're confident in their growth.
As a result, a low unemployment rate often has a positive impact on the stock market. On the other hand, a rising unemployment rate affects the stock market negatively. A rising rate shows businesses aren't hiring and therefore may not be growing.
Stock market
The stock market is undoubtedly one of the economic indicators that gets the most attention. And investors see the effects of it each day when they check their retirement and other brokerage accounts.
Stock market broadly refers to all of the exchanges where stocks are bought and sold. However, when people analyze stock market movement, they usually consider only the key indexes like the S&P 500 or the Dow Jones Industrial Average.
The stock market is generally proactive rather than reactive. It indicates what investors expect to happen in the economy rather than what's already happened. The stock market goes up if investors expect the economy to grow. On the other hand, the stock market is likely to slow or take a turn for the worse if investors anticipate an economic downturn.
Price indexes
There are two major price indexes that are used as economic indicators: the consumer price index (CPI) and the producer price index (PPI).
The CPI is a measure of the prices of goods and services. The BLM calculates this number by looking at the average change of prices that urban customers pay for goods and services. These include food, clothing, transportation, health care and more. The BLM publishes the CPI on a monthly basis. The CPI helps economists measure inflation. A rise in the prices of goods and services indicates inflation. Falling prices indicate deflation.
The PPI is a measure of the prices received by domestic producers. Like the CPI, the PPI measures the changes in prices. The CPI measures the price that consumers pay. The PPI measures the sale price that producers receive. The PPI generally reflects inflation before the CPI does. As a result, it can be a sign of things to come.
The PPI also measures a broader selection of items. The CPI measures only the prices that urban consumers pay. The PPI spans the entire country. The CPI measures only a sample of goods and services. The PPI measures all industries.
Interest rates
An interest rate is a percentage that lenders charge borrowers on loans and other debt. Rather than being a sign of what's to come in the economy, interest rates are a tool that the Federal Reserve uses to control economic growth.
When the economy is growing rapidly, the Fed often increases interest rates as a way to slow economic growth and therefore inflation. And when the economy is lagging, the Fed is likely to lower interest rates to stimulate economic growth.
Interest rates can be a useful tool for investors. They indicate how the government perceives the economy's health to be. Interest rates also help individuals and businesses make purchasing decisions. A lower interest rate means it's cheaper to borrow money. People often make large purchases when interest rates are lower.
Find out more:Â Why Would the Fed Want Inflation?
Consumer confidence and consumer sentiment
The Consumer Confidence Index (CCI) and the Consumer Sentiment Index (CSI) are signs of how consumers feel about the current state of the economy. Both show how confident consumers are in the current economy. The Conference Board publishes the CCI on the last Tuesday of every month. The University of Michigan publishes the CSI twice per month.
Retail sales
Each month, the U.S. Census Bureau publishes the retail sales report, which is a measure of all sales by U.S. retail stores. Retail sales can be an indicator of consumer confidence. A rise in consumer spending generally means consumers feel confident in the economy. As a result, rising retail sales often cause a rise in the stock market. On the other hand, a decrease in retail sales signals a lack of confidence by consumers and can cause a drop in the stock market.
Durable goods orders
Durable goods, also known as consumer durables, are those products that consumers generally purchase less frequently than every three years. They include pricier items like cars and home appliances. Each month, the Census Bureau publishes a report on durable goods. Like retail sales data, durable goods orders can be a sign of consumer confidence in the economy. A rise in durable goods orders generally signals good economic health. A decline in orders can be a sign of trouble to come.
How to use economic data as an indicator
It's one thing to know what the most important economic indicators are. It's an entirely different thing to know how to use them. After all, if you understand what different economic indicators mean, you can use them to make wise investing and purchasing decisions. You can also gain some insight into why the Fed and policymakers make certain decisions.
First, understand which indicators are relevant to you as an investor. There are many different indicators. It would be nearly impossible to stay up to date on all of them unless that's your job. So decide which indicators are most relevant to your situation.
It's also important to understand what each indicator means. Looking at a lagging indicator as a sign of things to come simply wouldn't be helpful. Those indicators reflect economic events that have already happened. Similarly, a leading indicator may not be helpful in telling you how the economy stands today. Those predict future economic events.
Also know that you don't have to closely follow all of the economic indicators to be a successful investor. In general, time in the market beats timing the market. Even the best economists and most successful investors can't time the market perfectly. With a long-term investment strategy of index fund investing or buy-and-hold investing, the ebbs and flows in the market won't be as important.
If you do closely follow economic indicators and use them in your investment strategy, take them with a grain of salt and avoid impulsive and emotional decisions. Take a measured approach since individual indicators may not provide much context and may not tell the whole story.
The bottom line
Economic indicators can be useful tools in understanding the current state of the economy and predicting what may happen in the future. Some of the most important indicators include the GDP, CPI, and unemployment rate. While these indicators can help to guide your investment decisions, it's important to look at them in a broader context.
