Upbeat music plays throughout.
Narrator: Whether it's consumer spending driving up company revenues and boosting their stocks, or high unemployment causing the Fed to lower interest rates, the economy can directly affect the market and subsequently, your investments.
But it can feel overwhelming to try and determine the economy’s overall health.
Thankfully there are tools to help you get an idea of whether it’s expanding, holding steady, or contracting. They're called economic indicators, and they're data about where the economy has been and where it might be going.
Learning what economic indicators reveal about the economy’s health can help you make decisions about your investments—like a doctor uses stethoscopes and blood tests to determine a patient's health. Each economic indicator typically has a different purpose and a varying level of importance to the economy, which represents everything being made, consumed, and traded in the country.
There are three broad categories of economic indicators, and we're going to look at each in this video: leading indicators, which can give you insight about future trends; coincident indicators, which can tell you about what's happening right now; and lagging indicators, which can confirm some kind of trend is already happening.
Let’s dig in.
The future of the economy is what most people think about when they're trying to make decisions about their investments, which is why leading indicators draw a lot of attention. The stock market itself can actually be a leading economic indicator.
The S&P 500® index tracks the performance of 500 of the largest companies listed on stock exchanges in the U.S.
One consideration that drives investors to buy or sell stocks is their expectations of a company's future success, not just its present earnings. If the index is rising or falling, it can give you insight about whether investors think there's a bright future for the underlying businesses. And because the S&P 500 measures so many different types of stocks from a broad range of industries, it's thought of as a comprehensive view of how things are looking in the overall economy.
So, while the stock market is not the economy, the direction stocks are moving can give you a sense of where the investing world thinks the economy is going.
Another common leading indicator is the Institute of Supply Management's purchasing managers' index, or PMI. While the S&P 500 captures overall expectations from across the economy, the manufacturing PMI focuses on specifics like companies' production and inventory levels. It can be a gauge of the demand for goods that drives economic expansion. If the index shows a reading above 50, it's a sign of growth in manufacturing, while less than 50 indicates contraction. New orders are of particular interest because growth can be a good sign of overall demand.
Other leading indicators focus on consumers. The Consumer Confidence Index® offers a look at how people feel about their financial situation, the future, and other economic issues.
It's relevant because so much of the U.S. economy is driven by consumption. The federal government also publishes a few surveys that are leading indicators, including a monthly one on new orders for manufactured durable goods and a weekly report on the number of initial jobless claims. A spike in initial jobless claims could be a sign of trouble to come.
Other data about jobs are coincident indicators because they can clarify the perspective on the economy today. They can also give insight about where the economy is in its broader cycle of expansion and contraction.
One of the primary coincident indicators is the nonfarm payrolls report. Near the beginning of every month, the U.S. Department of Labor releases a report on jobs created, wage gains, the labor participation rate, and unemployment.
Seasonal jobs like planting and harvesting are excluded to give a more realistic look at full- and part-time job creation. The thinking is that if we see that people are working and making money, the economy is humming along just fine.
New jobs, low unemployment, and higher wages usually translate into higher spending and greater economic activity.
That's why the personal income data released every month by the Bureau of Economic Analysis is another valuable coincident indicator. The report monitors not only wages and salaries, but also Social Security and other government benefits, dividends and interest, and income from less common sources. It offers a comprehensive look at the current state of Americans' financial health and spending, as well as a view on whether increases to income are in line with inflation.
It would seem to be good for the economy that people have more money because they could potentially buy more. But doing so can cause prices to rise, and inflation can cancel out increases in income.
That's one reason many investors closely keep an eye on gross domestic product, or GDP. It's a coincident indicator that measures the market value of everything that's produced in a country at a specific time, so it can be compared to previous periods. It not only can suggest how productive an economy is, it can also give insight about how prices and income are affecting consumption. Average weekly hours worked in manufacturing is another indicator that reveals the effort put into goods being made. If the number is increasing, it may mean that more is being made, which is typically a good sign for the economy.
While the present and future are important, lagging indicators can give vital insight about where the economy has been because that can tell you what conditions people are dealing with.
The Consumer Price Index, or CPI, is one of the most closely watched lagging indicators because it can show how Americans' purchasing power changes over time.
The Bureau of Labor Statistics publishes the change in prices each month as an inflation rate, which is useful to compare to changes in previous months or years. Most investors and government officials care about observing the trend in the rate change because it can confirm things about inflation, like whether it is getting too high and becoming a detriment to the economy.
If inflation isn't outpacing growth in personal income, however, it probably means things are looking OK.
CPI data showed that prices increased 3.4% in 2023 from the previous year, which was higher than officials want, though better than the 6%–7% range that lasted through 2021 and 2022. The Federal Reserve handles all of the monetary policy in the U.S. and it has a goal of a 2% rate. If prices are increasing at a fast rate, people may pull back on discretionary spending.
The unemployment rate is another lagging indicator that can provide similar insight. The rate measures the number of unemployed people against the overall labor force, and a low rate can be a signal that the economy is firing on all cylinders. But it can also be a harbinger that things are reaching their limit, which is why context is always important with these indicators.
It's also why people look at so many indicators when making decisions about where to invest, like corporations' annual and quarterly earnings, retail sales reports, and the relative strength of U.S. currency, among others.
So, how can these indicators actually influence your investing decisions? It can be hard to predict how individual data releases will affect markets, but big moves generally happen if information is unexpected.
This data is often more useful for longer-term investing decisions, especially if you try to utilize multiple indicators in concert to see if they point toward the same trend.
For example, if the latest CPI report shows a 5% increase instead of 3.4% increase, and the Consumer Confidence Index has simultaneously dipped, it may make you reconsider your investments in housing stocks— especially if the Fed is thinking about boosting interest rates to try to control inflation.
Paying close attention to where the economy is in its regular cycle is important, too, because it helps with analyzing the sectors of the stock market. It could also encourage you to rotate out of a cyclical stock like an airline, for example, and into a more stable utility stock, like a power company. Economic indicators are a key tool to making observations about where you want to allow risk in your portfolio allocations.
Most economic indicators publish on a weekly or monthly basis. You can find the Research tab on schwab.com.
For more Insights & Education, check out our other educational content under the Learn tab in your Charles Schwab account or on the Charles Schwab YouTube channel.
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