What is a 'Leading Indicator'
A leading indicator is a measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators are used to predict changes in the economy, but they are not always accurate. Bond yields are a good leading indicator of the market, because investors can use them to anticipate and speculate on trends in the economy.
BREAKING DOWN 'Leading Indicator'Leading indicators are used to gain some sense of which way the economy is headed. Investors use them to adjust their strategy to benefit from future market conditions. Federal policymakers use them for considering adjustments to monetary policy. Businesses use them to anticipate economic conditions that will affect their revenue. In practice, leading indicators are not always accurate predictors of the future. However, when used in concert with other data, they can reveal certain trends which support the probability of changing conditions.
Leading Indicators for the Economy
There are a number of leading indicators used in economic forecasting. Most of these indicators are based on aggregate data gathered from accredited sources focusing on specific aspects of the economy. The Durable Goods Report (DGR), which is developed from a monthly survey of heavy manufacturers, is used as a barometer for the health of the durable goods sector. The Purchasing Managers Index (PMI) is another survey-based indicator watched closely by economists in predicting growth in gross domestic product (GDP).
One of the more accurate leading indicators is the Consumer Confidence Index, which surveys consumers about their perceptions and attitudes. A rise or fall of the index is a strong indication of the future level of consumer spending, which accounts for 70% of the economy.
Leading Indicators for Investors
Investors watch many of the same leading indicators as economists, because the health of the economy directly impacts the direction of the stock market. However, investors tend to track indicators that can more directly influence the stock market. For example, the number of jobless claims, which is reported weekly by the U.S. Department of Labor, provides a timely look at the health of the economy. When jobless claims rise, it is a sign of a weakening economy. When they fall, it is an indication that companies are more confident about their prospects for growth.
Leading Indicators for Businesses
Successful businesses do an excellent job of tracking their bottom line and their balance sheet, but the data used for those reports are lagging indicators that may have no bearing on the future. One of the most effective leading indicators for businesses is the measure of customer satisfaction. For example, an increase in customer complaints can be indicator of problems in production or distribution, which, if detected early, could prevent the loss of market share.