What Is a Bellwether?
A bellwether is a leading indicator of an economic trend. To investors, a bellwether is usually a company that is worth watching closely because its earnings logically suggest a larger economic trend. A company's stock may also be a bellwether if it is viewed as pointing towards an upward or downward trend in a sector.
FedEx is an example of a bellwether company. If FedEx announces a substantial increase in deliveries in a quarter, it follows that consumer spending is increasing. More goods are being manufactured to fill more wholesale orders, more wholesale orders are being sent to retailers, and retailers are buying more to meet consumer demand.
- A bellwether is a leading indicator that suggests a larger economic trend.
- A bellwether company is watched closely, as its ups and downs are seen as signaling a change in direction for its industry or the economy as a whole.
- A bellwether stock is seen as predicting the performance of the market or a sector of it.
- Bellwether companies are usually market leaders in their respective sectors and may be considered blue chips.
- While bellwether stocks may indicate future trends, they are not always the best investments in a sector.
Understanding a Bellwether
The performance of FedEx and a number of other public companies are considered by analysts to indicate the direction of the economy and the financial markets because their performance is well-correlated with a general trend. Bellwether companies are usually market leaders in their respective sectors and may be considered blue chips.
A bellwether stock is a stock that is used to gauge the performance of the market or macro-economy. A stock's status as a bellwether may wane over time, but in the equities markets, the largest and best-established companies in an industry are often its bellwethers.
Usually profitable and stable, most bellwether stocks have proven themselves in an industry with established customer bases and formidable brand loyalty. Some prove to be resistant to economic downturns.
These stocks also form the foundation of most major market indices; large-cap bellwethers such as Boeing Co. and Johnson & Johnson dominate the Dow Jones Industrials and the S&P 500.
While bellwether stocks may indicate future trends, they are not always the best investments in a sector. Once a company achieves bellwether status, its fastest growth days are usually well behind it and its enormous size makes meaningful expansion difficult.
Instead, investors may use bellwether stocks as indicators while actually putting their money into up-and-coming stocks with plenty of growth potential ahead of them. These may well be the bellwethers of the future.
The word is a combination of bell and wether, a castrated ram. Shepherds hang a bell around the neck of a sheep that leads the flock to make it easy to locate the flock in the fields.
Similarly, political bellwethers tend to be a leading indicator relating to voting trends and elections. Usually, political bellwethers reference the voting behavior of a specific state or county that gives larger indicators to a national trend. The best example of this is Ohio--a state that has voted for the winning presidential candidate with 93% accuracy since 1900. As a result, when watching elections, many will look towards how Ohio is voting as a solid indicator for the presidential winner.
Similarly, Sandoval County in New Mexico is considered a bellwether because it gives a good pulse on national politics in swing states; in that county, there is a pretty moderate political sentiment, so that in some years, it swings red, and other years, it swings blue. Whenever it does, analysts will look at Sandoval County--which has been 92% accurate in predicting swings in the national electorate--for a pulse check on the country.
Advantages and Disadvantages of Bellwethers
Bellwether stocks, which are also known as barometer stocks, can be helpful starting points in predicting the overall direction that an industry is headed, such as bullish and bearish behavior. Especially in investing where there is so much uncertainty to be accounted for, bellwethers offer some indication of how the market is moving. However, it should be noted that bellwethers are not determinants of the future, either: correlation doesn't always equal causation.
Especially when it comes to bellwether stocks, such as blue-chip stocks, their overall financial health can greatly swing markets. However, these and other bellwether stocks tend to be companies that are established, stable, and financially sound. Oftentimes, however, that means that its growth days are long over. Newer and emerging companies may actually show more growth and be wise investments; only looking to bellwether stocks could misconstrue this potential.
Use historical data for helpful predictions of future behavior
Give early indicators of shifting market conditions
Are relatively simple pulse checks
Not always a good gauge for companies or industries of different sizes
Bellwethers do not guarantee a certain outcome
Potential to place too much emphasis on a bellwether
Examples of Bellwethers
"What's good for GM is good for America" is a famous adage that speaks to General Motors' bellwether status in the U.S., mainly from the 1940s through the 1980s. It is still the biggest of America's "Big Three," but it is no longer the dominant bellwether for the economy.
Today's bellwethers are giants in their sectors, and are watched for slightly different reasons:
- FedEx, as noted above, is watched as a bellwether that indicates strength or weakness in consumer spending. If FedEx is busy delivering, consumers are busy buying.
- Alcoa is a bellwether because the aluminum it produces is used in a wide spectrum of industries from aerospace to beverage containers. Alcoa is in a cyclical industry. If it is stepping up production, other industries are producing more. It has the added attention-grabbing advantage of being the first major company to report its quarterly earnings.
- LVMH Moet Hennessey Louis Vuitton is a giant among luxury goods makers. If people are shopping at Tiffany & Co. and Bulgari, there's money being spent out there.
What Is a Bellwether State?
A bellwether state is one whose voting behavior gives larger indicators to a national trend, often in a presidential election. Ohio is considered a bellwether state because it has accurately voted for the winning presidential candidate with 93% accuracy since 1900.
What Is a Bellwether Settlement in Law?
Bellwether trials in law are when one plaintiff is chosen from a pool of multiple parties as a representative of the "typical" case -- such as when a group of individuals sue a medical device company for a faulty product.
What Is a Bellwether in Computer Science?
In computer science, bellwethers refer to historical data points that help with improved prediction accuracy for a different data set.
The Bottom Line
However you interpret the behavior of a bellwether, they are companies to watch closely, especially if historical data backs up their behavior. For investors who are following the market, bellwether stocks can provide a useful first pulse check on larger economic trends.