An economic indicator is a statistic that is used to measure current conditions and to forecast future trends. The key indicators for U.S. stocks are the major American stock indexes.
They include the Dow Jones Industrial Average (DJIA), the Standard & Poor's 500 Index (S&P 500), and the Nasdaq Composite Index (NASDAQ).
- The DJIA, the S&P 500, and the NASDAQ indexes all are indicators of the current state of the stock markets.
- They reflect investor confidence and thus may be indicators of the health of the overall economy.
- Other indicators such as GDP more directly measure the direction of the wider economy.
Each of these indexes was created as a way to capture the status of the stock markets or a sector of the markets from one day (or one moment) to the next. They indicate whether "the markets" as a whole are up or down, a little or a lot.
Leading Indicators and Indexes
Each of the three most closely followed indexes has its own history and its own followers among financial professionals and the media.
- The DJIA also referred to as the Dow, is the old original, created in 1896. It tracks just 30 companies, all leaders in their industries. The word "industrial" in the name dates from an era during which the most important American companies were its industrial titans. To this day, it is the most highly used and frequently quoted of all the leading stock market indicators.
- The S&P 500 Index is made up of 500 stocks from across all industry sectors. Some investors consider it to be a more accurate gauge of the markets as a whole because it has broad representation and it's value-weighted. That is, each component's weight in the index is proportionate to its market value.
- The Nasdaq Composite Index tracks more than 3,000 stocks listed on the Nasdaq Stock Exchange. Because of the makeup of that exchange, the index includes many younger companies large and small, particularly in the technology, biotechnology, and pharmaceutical sectors.
These three indexes serve as important indicators of the health of the markets overall. Other indicators are used to track the immediate past performance of the economy, and to forecast its future.
Lagging and Leading Indicators
Most other economic indicators are government reports or surveys that only make sense in the context of time. That is, if an indicator is up compared to a month earlier, the economy is strengthening. If the indicator is down this month, the economy is weakening.
Some consider the S&P 500 to be an accurate gauge of the markets as a whole because it has broader representation and is value-weighted.
The economic indicators most often used by analysts and investors include gross domestic product (GDP), the Consumer Price Index (CPI), the nonfarm payroll report, and the Consumer Confidence Index. There are others, such as manufacturing orders and building permits, that are of particular relevance to investors in certain sectors.
Indicators are either lagging indicators or leading indicators. Lagging indicators allow analysts to track the direction of the economy, or a substantial component of it, over time. Leading indicators suggest which way it's going next. The manufacturing orders number, for instance, indicates how much demand buyers see for new products during the upcoming months.
The Big Numbers
No indicator is more closely watched over time than GDP. This measures the total value of all goods and services produced in the U.S. It reflects all of the consumption that has occurred in both the public and private sectors. GDP reports are issued quarterly and annually. The number for the second quarter of 2020 was $19.41 trillion.
CPI tracks the cost of living in the U.S. by tracking the prices of a mixture of consumer goods and services.
The monthly nonfarm payroll report tracks the health of the job market by measuring the hours and salaries of most (but not all) nonfarm workers. It omits government employees, self-employed workers, and employees of non-profit groups as well as farmworkers.
The consumer confidence index is another leading indicator. This closely-watched survey assesses the degree of optimism or pessimism that consumers feel for the economy and their own financial security. This logic is that the more optimistic consumers are, the more money they will be willing to spend in the near future.