It is rare to hear any long discussion of the stock market without some mention being made of the economic outlook. As of mid-August of 2010, the preeminent worry is whether the U.S. economy is sliding back into recession or whether it will manage to sustain an ongoing (if weakened) recovery.

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Given that the economists on business TV seem to live to disagree, what should a regular investor do? Just what should an economic recovery look like? Follow these economic indicators for signs of a recovery.

  1. Employment
    It is difficult to talk about an economy in recovery if people are not getting back to work. There are such things as "jobless recoveries", where there is enough economic activity to get businesses moving again, but not enough to stimulate hiring.

    In most other cases, however, investors are right to correlate an improving economy with people getting back to work. The reported unemployment rate, then, is often given a great deal of weight by observers. Keep in mind, though, that unemployment data is not always reliable in the early stages of a recovery - the quirks of the statistical method's use exclude those who have abandoned the search for work, but when a recovery seems plausible, some of these people resume their search and count once again among the unemployed.

    Non-farm payroll is another valuable measure - it gives a somewhat clearer sense of how many people companies are hiring. Along with the number of people added (or subtracted) from payrolls, investors can see where these workers are going and where wages are trending.

    Along with metrics like unemployment and non-farm payrolls, investors can also follow the lesser-known ASA Staffing Index. This index measures activity in the temporary staffing industry; often when employers seek to add workers, they add temporary workers first so as to avoid the commitments and expenses of adding full-time employees ahead of a confirmation that business has improved. As such, a climbing ASA Staffing Index can signal that a recovery is underway.

  2. Consumer Spending
    For better or worse, the U.S. economy is driven by consumer spending. Consequently, it is difficult to imagine a recovery that does not include rebounding consumer spending. Longer term, consumers may realize that they should save more and spend less, but that sort of restructuring does not occur overnight. Look for consumers opening their wallets as a sign of a recovery. (For further reading on economic indicators, check out our Economic Indicators Tutorial.)

  3. Consumer Sentiment
    Perhaps it is a testament to the power of positive thinking, but sentiment indicators like the Consumer Confidence Index (CCI) and the Michigan Consumer Sentiment Index do seem to correlate with reality more often than not. These surveys ask people how they feel about the economy in near-term and their own individual or family prospects.

    Ultimately, sentiment is somewhat of a self-fulfilling prophecy; if there is a constant drumbeat of how bad things are, people often become more conservative in their spending habits. Lower spending will then more or less make the economic soft patch happen. When people are more optimistic, though, they are more likely to spend money, start or expand small businesses, and otherwise act in ways that are good for economic growth.

  4. Business Indicators
    How consumers feel about the economy is all well and good, but it has to be matched by optimism and expansion in the business community. The Purchasing Managers' Index (PMI) surveys whether businesses are seeing new orders, higher production levels, timely deliveries from suppliers and increasing inventories and employment, all areas where a recovery will show itself.

    Inventories, however, are harder to correlate as many businesses will look to run down inventories before committing to an expansion of production. This choppiness is often an issue in early economic recoveries as businesses do not want to miss the turn in the economy (and let their rivals capture share), but they do not want to overextend themselves either.

  5. Bank Lending
    While public companies are not entirely dependent upon banks to grow their businesses, most small non-public businesses are. Without banks underwriting new loans, small businesses do not grow, and without that growth it is difficult to see higher employment and a stable recovery.

    The Federal Reserve provides regular information on bank lending activity, and investors can perhaps also look to the new Thomson Reuters/PayNet Small Business Lending Index to see whether small businesses are seeking (and getting) the funds to expand their businesses. (To find out more about the actions of the Federal Reserve, check out our Federal Reserve Tutorial.)

  6. Shipping Activity
    Shipping activity is a bit harder to read than other indicators, but the basic idea is straightforward - since most people buy things that come from "someplace else", overall economic activity is correlated with the movement of goods across the continent. Notable indexes here include the Cass Freight Index and the American Trucking Association's Truck Tonnage Index. (This index can provide insight into economic growth and production, but it has its critics. To learn more, see The Baltic Dry Index: Evaluating An Economic Recovery.)

The Bottom Line
None of these indicators are foolproof, or even all that useful in isolation. Every economic cycle is a little different than prior cycles, so investors should be careful about automatically applying old rules to new data. There is a certain amount of common sense that should guide investors. Economic growth means certain things - namely increasing production, increasing consumption (or savings), increasing employment, and increasing activity in areas like construction and transportation. By keeping a careful eye on whether businesses are preparing for growth, whether consumers feel comfortable about spending, and whether money and goods are moving through the economy, investors can get a sense of whether the next recovery is real.

Catch up on your financial news; read Water Cooler Finance: Billionaire Pledges and Other Positive Press.

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