What Is Economic Indicator?
An economic indicator is a piece of economic data, usually of macroeconomic scale, that is used by analysts to interpret current or future investment possibilities. These indicators also help to judge the overall health of an economy.
Economic indicators can be anything the investor chooses, but specific pieces of data released by the government and non-profit organizations have become widely followed. Such indicators include but aren't limited to:
- An economic indicator is a macroeconomic measurement used by analysts to understand current and future economic activity and opportunity.
- The most widely-used economic indicators come from data released by the government and non-profit organizations or universities.
- Indicators can be leading—which tend to precede trends, lagging—which confirm trends, or coincident—that which is happening now.
Economic Indicator Explained
Economic indicators can be divided into categories or groups. Most of these economic indicators have a specific schedule for release, allowing investors to prepare for and plan on seeing certain information at certain times of the month and year.
Leading indicators, such as the yield curve, consumer durables, net business formations, and share prices, are used to predict the future movements of an economy. The numbers or data on these financial guideposts will move or change before the economy, thus their category's name. Consideration of the information from these indicators must be taken with a grain of salt, as they can be incorrect.
Coincident indicators, which include such things as GDP, employment levels and retail sales, are seen with the occurrence of specific economic activities. This class of metrics shows the activity of a particular area or region. Many policymakers and economists follow this real-time data.
Lagging indicators, such as gross national product (GNP), CPI, unemployment rates and interest rates, are only seen after a specific economic activity occurs. As the name implies, these data sets show information after the event has happened. This trailing indicator is a technical indicator that comes after large economic shifts.
Interpreting Economic Indicators
An economic indicator is only useful if one interprets it correctly. History has shown strong correlations between economic growth, as measured by GDP, and corporate profit growth. However, determining whether a specific company may grow its earnings based on one indicator of GDP is nearly impossible.
Indicators provide signs along the road, but the best investors utilize many economic indicators, combining them to glean insight into patterns and verifications within multiple sets of data.
There is no denying the objective importance of interest rates, gross domestic product, and existing home sales or other indexes. Why objectively important? Because what you're really measuring is the cost of money, spending, investment, and the activity level of a major portion of the overall economy.
The Stock Market as an Indicator
Leading indicators forecast where an economy is headed. One of the top leading indicators is the stock market itself. Though not the most critical leading indicator, it’s the one that most people look at. Because stock prices factor in forward-looking performance, the market can indicate the economy’s direction, if earnings estimates are accurate.
A strong market may suggest that earnings estimates are up, which may suggest overall economic activity is up. Conversely, a down market may indicate that company earnings are expected to suffer. However, there are limitations to the usefulness of the stock market as an indicator because performance to estimates is not guaranteed, so there is a risk.
Also, stocks are subject to price manipulations caused by Wall Street traders and corporations. Manipulations can include inflating stock prices via high-volume trades, complex financial derivative strategies and creative accounting principles—both legal and illegal. The stock market is also vulnerable to the emergence of “bubbles,” which may give a false positive regarding the market’s direction.