Government agencies, industry groups, and non-profit organizations generate a nonstop flow of statistics on the U.S. economy. Economic indicators provide real-time information on the direction of the economy as it relates to economic growth, inflation, jobs, and the health of the financial markets, according to economists.
Do you ever wonder what those reports really mean or why they're important to you as an investor?
Investors use the economic data to interpret current or future investment possibilities and judge the overall health of an economy. The key information to extract from these indicators is how far they differ from what was expected. Financial markets are forward-looking, and securities prices incorporate economists' consensus forecasts for economic growth, inflation, jobs, etc. Markets react to an indicator only when the actual release of that indicator comes above or below what was originally expected.
The best investors will utilize many economic indicators, looking for patterns and verifications within different sets of data. Some major economic indicators are regarded as to more likely influence the markets and so are widely followed include gross domestic product (GDP), consumer price index (CPI), and unemployment rate. The followings are short introductions of those primary economic indicators.
Gross domestic product, commonly referred to as GDP, is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. GDP measures the overall value of the goods and services produced by the U.S. economy in a specific time period; and is often thought of as the most important economic indicator. GDP is made up of several factors, including public consumption or consumer spending; business investment; federal, state, and local government spending; and net exports (exports less imports).
Real Economic Growth Rate builds onto the economic growth rate by taking into account the effect that inflation has on the economy. It is a measure of economic growth from one period to another expressed as a percentage and adjusted for inflation (i.e. expressed in real as opposed to nominal terms). The real economic growth rate is a measure of the rate of change that a nation's gross domestic product (GDP) experiences from one year to another. The real economic growth rate is a more accurate look at the rate of economic growth because it is not distorted by the effects of extreme inflation or deflation.
Estimates of GDP growth are made each quarter, and the rate of growth or contraction is then expressed as an annual figure. A growing economy typically means more jobs, higher incomes, and more businesses generating profits. For these reasons, GDP growth is often regarded as good news for the financial markets.
However, it's possible to have too much of a good thing. If consumer and business spending are growing too rapidly, investors may worry that it will lead to a shortage of goods and workers, pushing prices and labor costs higher and causing inflation to rise.
One of the most important factors for investors to watch is inflation or deflation, and the best-known indicator of inflation or deflation is the Consumer Price Index (CPI). Large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation. Inflation means the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. As inflation rises, every dollar will buy a smaller percentage of a good.
The CPI tracks the prices of goods and services purchased by consumers. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance.
Core CPI is released at the same time as CPI and is a measure of the prices of goods and services, minus food and energy prices, which tend to be more volatile.
The Producer Price Index (PPI) tracks prices received by producers for their finished products. If the PPI goes up, it's another good indicator that inflation is on the rise.
If inflation rises too quickly, it could trigger the Federal Open Market Committee (FOMC) to raise interest rates in an effort to slow down the growth of the economy and thus take some pressure off prices. If interest rates rise, bond and stock prices may drop. On the other hand, when interest rates have fallen significantly, consumers and businesses tend to increase spending, causing bond and stock prices to rise.
The unemployment rate is the percentage of people in the total workforce who are unemployed and actively seeking jobs, including new entrants into the workforce as well as people who have lost their jobs and are looking for new ones. Each month, the U.S. Department of Labor gathers employment data by surveying individuals and businesses.
The unemployment rate is considered a lagging indicator, confirming but not predicting long-term market trends. Rising unemployment generally signals a slowing economy. Falling unemployment is usually good news, signaling economic growth that can benefit investors. However, investors sometimes grow concerned that very low unemployment rates will cause employers to bid up wages and benefits to attract workers, resulting in higher costs and more rapid inflation.
While the unemployment rate takes into account both previously employed people and new entrants into the workforce, a weekly report on jobless claims tracks people who have lost jobs and applied for unemployment compensation. This can be an early indicator of changes in employment trends and in the overall economy. Higher initial claims correlate with a weakening economy.