Leading Indicators for Economy and Stocks

[Do Or Die 10]

Economic Indicators are among the most talked and closely watched pieces of news in the investment world. Practically every week there is some announcement that affects investors' predictions about the future of the economy. The important application of economic indicators is the study of Business Cycles.

 

Idealized Business Cycle in Stocks

 

 

 

Leading economic indicators are those which are believed to change in advance of changes in the economy, supposedly giving you a preview of what is going to happen before the change actually occurs. The other two broad type of indicators are coincident (which move along with business cycles) and lagging (which trail behind the economic cycle.

Let’s take a look at two widely tracked composite of leading indicators.

 

OECD Composite Leading Indicators

 

"The OECD CLI is designed to provide qualitative information on short-term economic movements, especially at the turning points, rather than quantitative measures... In practice, turning points in the de-trended IIP have been found about 4 to 8 months (on average) after the signals of turning points had been detected in the headline CLI.

Potential leading indicators are classified to one of four types of economic rationale, that can be used to assess their suitability as leading indicators.

• Early stage: indicators measuring early stages of production, such as new orders, order book construction approvals, etc.
  
• Rapidly responsive: indicators responding rapidly to changes in economic activity such as average hours worked profits and stocks.
  
• Expectation sensitive: indicators measuring, or sensitive to, expectations, such as stock prices, raw material prices and expectations based on business survey data concerning production or the general economic situation/climate e.g. confidence indicators.
  
• Prime movers: indicators relating to monetary policy and foreign economic developments such as money supply, terms of trade, etc"
  

 

FRED Leading Index for the United States

 

FRED stands for Federal Reserve Economic Data. "The leading index for US (supposedly) predicts the six-month growth rate of the state’s coincident index. In addition to the coincident index, the models include other variables that lead the economy: state-level housing permits (1 to 4 units), state initial unemployment insurance claims, delivery times from the Institute for Supply Management (ISM) manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury bill."

 

Here are the two leading indicators composite overlayed with S&P 500 (click to enlarge).

 

 

 

Suprise! the S&P 500 leads the leading indicators composite. For the average stock investor, the leading indicators may serve no other purpose than scaring him to sell at the market bottoms.

[jannaR 10]

This is a great post. This would be helpful for those who keeps on watching the thread of the economy and I think everyone should be aware about this matter because this would guide us in our economic related activities considering the fact that we are the ones who are dictating to where the economic status would go, whether to rise or to fall. This is more important at present due to economic crisis that we are experiencing specially that the US economy gets worse as time pass by and that's what recent reports suggest. In fact, over three-fourths of Americans distrust financial system at present and the American consumer's mistrust of the country's economic system proceeds to increase. More than three in four Americans interviewed said they do not trust the country's financial system. Analysts say that regulators can work to rebuild that confidence. But consumers also need to be monetarily literate to observe the program. Yes, we, as consumers, should be financially literate to help the country get rid of economic crisis and do not merely depend on the president and the government officials. We should have self discipline when it comes to financial matters considering the fact that it's all what we can do to help make a better national economy.