What Is a Leading Indicator?
A leading indicator is a measurable set of data that may help to forecast future economic activity. Leading economic indicators can be used to predict changes in the economy before the economy begins to shift in a particular direction. They have the potential to be useful for market observers, investors, and policymakers.
- A leading indicator is a piece or set of economic data that may correspond with a future movement or change in the economy.
- Economic leading indicators can help to predict and forecast future events and trends in business, markets, and the economy.
- Different leading indicators vary in their accuracy, precision, and leading relationships, so it is wise to consult a range of leading indicators in planning for the future.
- The index of consumer confidence, purchasing managers' index, initial jobless claims, and average hours worked are examples of leading indicators.
Understanding Leading Indicators
Leading indicators must be measurable in order to provide hints as to where the economy is headed next. Investors use these indicators to guide their investment strategies as they try to anticipate market conditions. Policymakers and central bankers use them when setting fiscal or monetary policy. Businesses use them to make strategic decisions as they attempt to anticipate how future economic conditions may affect markets and revenue. The following are some examples of leading economic indicators.
Purchasing Managers Index
Leading indicators are often based on aggregate data gathered by respected sources and focused on specific facets of the economy. For example, economists closely watch the Purchasing Managers Index (PMI) as a leading indicator. The PMI reflects trends in the manufacturing and service sectors and can be a useful signal of growth in a nation’s gross domestic product (GDP) due to changes in the demand for materials from corporations.
Durable Goods Orders
Durable goods orders is another type of leading indicator for businesses. This is a monthly survey of manufacturers that is produced by the U.S. Census Bureau and measures industrial activity in the durable goods sector and the state of the supply chain.
Consumer Confidence Index
Like durable goods orders above, many people consider the Consumer Confidence Index (CCI) to be among the most accurate leading indicators. This index surveys consumers about their own perceptions and attitudes about the economy and where it is going.
Leading Indicators for Investors
Many investors will pay attention to the same leading indicators as economists, but they tend to focus on those indicators directly related to the stock market. These can include the housing market, retail sales, building permits, business startups, and more. Below are some of investors' more closely watched leading indicators.
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.
As another example, many market participants consider the yield curve, specifically, the spread between two-year and 10-year Treasury yields, a leading indicator. This is because two-year yields in excess of 10-year yields has been correlated with both recession and short-term market volatility. If an inverted yield curve occurs, it may signal that a recession is quickly approaching.
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.
A major leading indicator for businesses is performance. Customer complaints or negative online reviews are examples of leading indicators of customer dissatisfaction that may signal that there are problems with a businesses production or service. These can point to lower future revenue, growth, or profits. Conversely, positive customer satisfaction results may suggest that these factors could trend upward in the future.
Accuracy of Leading Indicators and How to Use Them
Leading indicators are not always accurate. However, looking at several leading indicators in conjunction with other types of data can help provide information about the future health of an economy.
Leading indicators often present trade-offs between accuracy, precision, and lead time in predicting future events.
While an ideal leading indicator would predict changes in economic trends or business performance accurately, within a narrow range of estimates, and over a long time horizon, in practice, all leading indicators show variable performance along these dimensions.
As a hypothetical example, with respect to the U.S. economy, capital goods new orders data can provide a far advance warning of downturns in the economy (long lead time), but the historical lead time between turning points in capital goods and a specific target indicator such as stock prices or GDP may range from 12 to 24 months (low precision), and the magnitude of changes in capital goods new orders might not bear any consistent relationship with the size of changes in GDP (inaccurate except as an indicator of timing). This indicator would be useful as a long-term warning sign, but would not support a precise estimate of the timing or size of future trends.
On the other hand, a leading indicator might give highly accurate and precise information about a turning point or trend in the market or the economy but only over a few months or quarters. Such an indicator would provide detailed input into estimating the trends that affect your business or investments, but might not provide that information in sufficient time to take full advantage of the insight gained.
By themselves, both types of leading indicators might be helpful, but neither provides the full picture needed to maximize performance. In practice, this means that using a range of different leading indicators that are more or less accurate, precise, and forward-looking can provide the best opportunity to capitalize on future trends.
What Are Leading and Lagging Indicators?
Leading indicators are measurable pieces or sets of data that may suggest future economic, business, or investment trends. A lagging indicator is a measurable figure or set of data that changes at some point after an economic or business trend occurs.
What Are the Three Main Types of Economic Indicators?
Leading indicators are one of the three main types of broader economic indicators. The others are lagging indicators and coincident indicators.
What Is an Example of a Leading Indicator?
There are many examples of leading indicators. One of the most famous is the Consumer Confidence Index (CCI). This is a survey regularly performed by The Conference Board to determine how optimistic or pessimistic consumers are about their expected future financial situation.
The Bottom Line
Leading indicators have the potential to be a highly valuable tool for economists, investors, business owners, and consumers. When used properly, they can signal likely upcoming changes and broad trends in the economy. However, the economy is not guaranteed to behave in the way that leading indicators suggest, and it is crucial that you know which indicators are most appropriate to evaluate and how to properly make use of them.