Know Good Things: Lagging Economic
Subtlety counts. If Mona Lisa had broken into a big toothy grin, she would have been forgotten long ago.” — Thomas Sowell
Howdy, gang! For the past several months, I have been attempting to lay the bedrock for a decent understanding of several types of economic models as well as the minds who brought us various schools of thought. At this point, I am going to delve into a more particular aspect of macroeconomic analysis as we get a little bit closer to our end goal of establishing this part of trading into our daily/weekly trading routines. There are three main types of events (indicators) that are unfolded upon us daily, weekly, monthly, and quarterly. It is my desire to go through those types of events and explain them as best I can. I will use data from the past to help illustrate the point, but as we complete this particular part of the journey we will then begin using current data.
Every day we are bombarded with an onslaught of material and events that shape not only the actual (broad) markets, but also our interpretation of the markets. Large sell-offs or rallies can occur throughout the day and the catalyst for these types of market runs can vary from individual company performance, news, earnings, legislation, or even natural disasters just to name a few.
Macroeconomic events are definitely one of those catalysts that shape our individual interpretation as well as prompt market participants to act or react. How can we use these events to our advantage and what should we be looking out for?
In the world of macroeconomics, there are three major types of indicators (events): coincident, leading, and lagging. Over the course of the next few issues of this blog, I will attempt to shed light on all three classifications in hopes that it will provide clarification in the minds of aspiring traders. The first classification we will explore is the lagging economic indicator.
First of all, what is an economic indicator? Simply put, an economic indicator is anything economic-related that can be used to forecast future economic (and therefore, market) trends. As more and more information is disseminated to the masses, we are able to analyze that information/data and create rather steadfast predictions of where the market has been, where it’s at, and where it may be heading. Lagging indicators are a look into where the economy (markets) has been, which is more helpful than one might think. In order to gauge the present, it would be wise to know the past. Without lagging indicators it would be extremely difficult to develop a sense of awareness for our present conditions.
Lagging indicators follow an event and can include a wide array of categories. In the world of economics, the most popular lagging indicator is the unemployment rate. This event is also one of the most politicized economic events we have access to, which is unfortunate because it gives the wrong impression. The unemployment rate, as current as it may be, is a look into the past. If the economy is in a recovery mode then the unemployment rate is unlikely to immediately follow and if you think about it then it actually makes plenty of sense.
When companies hire employees they usually don’t hire them on the prospects of good fortune, but rather because of good fortune. Hiring an employee is an expense in nearly every industry especially because of the payroll tax burden placed upon the employer. Unless the person being hired is an independent contractor or placed on a pure commission pay schedule the employer will have to make sure he or she can make pay-roll at the end of each pay period. So, it kind of goes without saying that a company will not hire new employees unless they can afford them and without new business developments, contracts, or opportunities then they will make do with the work force currently employed.
It would be a mistake to take the current employment rate in the United States and make an assumption of the economy or the markets. If the employment rate begins to change then it is changing because the economy has already been changing! Case in point being that the unemployment rate in the United States didn’t start increasing immediately as the economy crashed in 2008. There was a lag behind what the economy was doing and what the unemployment rates were showing.
Other types of lagging indicators include corporate profits and earnings reports, labor costs, interest rates, moving average crossover, value of outstanding commercial/industrial loans, the change in the consumer price index (CPI) for services from the previous month, the ratio of manufacturing and trade inventories to sales made, the ratio of consumer credit outstanding to personal income, average prime rate charged by banks, and the inverted average length of employment. All of the data provided by reports of these sorts help confirm economists’ assessments of current conditions and because it helps confirm the economic trends it also helps confirm the market trends.
Confirmation is the primary tool utilized by lagging indicators. In fact, when you decide to use any of the technical analysis indicators (such as MACD and Stochastics, for example) it is best that you use them as a way to confirm a decision you have already developed. When we use lagging indicators to actually make decisions for us we are, and will always be, late to the party.
Having a clear understanding of the type of indicator you are looking at regardless if it is a technical analysis or economic indicator is essential. We could use all the help we can get when it comes to making a trading decision, but if we are making those decisions under the wrong pretenses then it will inevitably affect our bottom line. In the grand scheme of things, being prepared is what it all boils down to. If we are prepared with knowledge and understanding then we are less likely to be surprised by the markets. If we are prepared then we can more easily reach our goals. I think the Boy Scouts have it right with their rather simple motto: Be Prepared.
Be good. Do good. Know good.