Everyday the news media questions the health of the U.S. economy and then connects that data to the past, present, and future movement of the stock market. What are the factors that determine economic health of our country?
What's behind the stock market's recent roller coaster ride? Perhaps, it's a reflection of widespread uncertainty driven by various economic factors, which include:
- Will tariffs lower company earnings?
- Will inflation start to rise again?
- Will the Federal Reserve lower interest rates, and if so, when and by how much?
- Will employment data weaken?
- Will the U.S. Dollar continue to weaken?
These questions make economic data releases some of the day's biggest financial headlines. Let's explore some common economic indicators and their significance.
Categories of Economic Data
Most economic data used to gauge the U.S. economy's overall health falls into three categories: Leading, Coincident, and Lagging Economic Indicators. We'll use common data points from indexes created by The Conference Board, a non-partisan think tank, to clarify their meaning.
Leading Economic Indicators predict the next phase of a business cycle by showing data that precedes economic events. Here are five essential ones:
- Interest Rates – The Federal Reserve controls the Federal Funds Rate, which helps to set rates that affect our everyday finances. As the Fed raises interest rates, it becomes more expensive to borrow money. Historically, higher interest rates cause businesses and consumers to decrease their spending, ultimately slowing down the economy. Conversely, when the Fed lowers rates, making borrowing cheaper, the economy tends to accelerate.
- Durable Goods Orders – This is a measure of new durable goods orders placed with domestic manufacturers. Durable goods are expensive items, such as computer equipment, industrial machinery, airplanes, and tanks, with a lifespan of three years or more. This measure can provide insight into how busy factories may be in the near future.
- Stock Market – This important leading indicator is a good measure of the overall trajectory of businesses. If the stock market is increasing, then shareholders have confidence in the future growth of U.S. businesses. A decline could potentially mean investors are exiting to invest their money into safer alternatives. This could signal a downturn in the economy.
- Manufacturing Jobs – This includes jobs in factories, plants, mills, and businesses that create new products directly from raw materials or components. If manufacturing jobs are high or on the rise, manufacturers employing these workers are likely to be confident in their business growth.
- Building Permits – These offer an insight into the construction sector of the economy. When building permits are high, it indicates companies are planning to build more homes. This sends a ripple effect throughout the economy – employment in the construction sector and consumer spending will both increase since these new homes will need to be furnished and landscaped.
Coincident Economic Indicators show the current state of economic activity, rather than predicting the future. Here are two key data points:
- Non-farm Payroll Employment – This tracks the monthly change in the number of full-time and part-time employees in the business and government sectors. A rise indicates job creation, while a decrease signifies job losses.
- Personal Income – This measures the monthly increase or decrease in income that households receive from all sources of real salaries and other earnings. This data point helps measure the general health of the economy and consumer spending.
Lagging Economic Indicators are a collection of data that can only be measured after a change has already occurred in the economy. These data points can be used to confirm trends or signal changes in trends. Here are two of the most important:
- Gross Domestic Product (GDP) – GDP is one of the most widely used indicators to assess the health of an economy. It represents the total value of U.S. production during a period (usually each quarter) within the country's borders. Based on the GDP, economists can determine if the U.S. economy is expanding or contracting.
- Consumer Price Index (CPI) – CPI measures U.S. inflation, the increase in the price of goods and services purchased by consumers over a given timeframe. The Federal Reserve's long-term target for inflation is historically around 2 percent.
Summary
We've covered nine economic indicators for examining an economy, though many more exist. Many are related, even if they appear in separate areas. Economists consistently debate which ones are more important when determining a country's current and future economic strength. By expanding your knowledge in this area, you can better understand why the stock or bond market reacts to economic data releases.
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The material has been gathered from sources believed to be reliable, however Bedel Financial Consulting, Inc. cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. To determine which investments or planning strategies may be appropriate for you, consult your financial advisor or other industry professional prior to investing or implementing a planning strategy. This article is not intended to provide investment, tax or legal advice, and nothing contained in these materials should be taken as such. Investment Advisory services are offered through Bedel Financial Consulting, Inc. Advisory services are only offered where Bedel Financial Consulting, Inc. and its representatives are properly licensed or exempt from licensure. No advice may be rendered unless a client agreement is in place.
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