What is a Leading Indicator
A leading indicator is any economic factor that changes before the rest of the economy begins to go in a particular direction. Leading indicators help market observers and policymakers predict significant changes in the economy.
Leading indicators aren’t always accurate. However, looking at leading indicators in conjunction with other types of data can help provide information about the future health of an economy.
For instance, many market participants consider the yield curve, specifically, the spread between two-year yields and 10-year yields, a leading indicator. This is because two-year yields in excess of 10-year yields is correlated with both recession and related market turbulence.
BREAKING DOWN Leading Indicator
Leading indicators must be measurable in order to provide hints as to where the economy is headed. Investors use these indicators to guide their investing strategies as they anticipate future market conditions. Policymakers use them when setting monetary policy. Businesses use them to make strategic decisions as they anticipate how future economic conditions may affect markets and revenue.
Leading indicators are often based on aggregate data gathered by respected sources and focued on specific facets of the economy. For example, economists closely watch the Purchasing Managers Index (PMI) in order to predict growth in a nation’s gross domestic product (GDP).
The Durable Goods Report (DGR), is based on a monthly survey of heavy manufacturers. It measures the health of the durable goods sector. Many people consider the Consumer Confidence Index (CCI) to be one of the most accurate leading indicators. This index surveys consumers about their own perceptions and attitudes about the economy.
Leading Indicators for Investors
Many investors pay attention to the same leading indicators as economists, but they tend to focus on indicators directly related to the stock market. One example of a leading indicator of interest to investors is the number of jobless claims. The U.S. Department of Labor provides a weekly report on the number of jobless claims as an indicator of the economy’s health. A rise in jobless claims indicates a weakening economy, which will likely have a negative effect on the stock market. If jobless claims fall, this may indicate that companies are growing, which is a good indication for the stock market.
Leading Indicators for Businesses
All businesses track their own bottom lines and their balance sheets, but the data in these reports is a lagging indicator. A business’ past performance does not necessarily indicate how it will do in the future. Instead, businesses look at customer satisfaction as a fairly accurate indicator of future performance. For example, customer complaints or negative online reviews often indicate problems related to production or service, and in some industries, may signal lower future revenue.