Following The Leader (Indicators)
A small glimpse into what’s to come: leading indicators
In the midst of uncertainty it may be difficult to predict where the economy is heading.
However, activity in certain areas have typically provided successful economic forecasts, these are respectively known as leading indicators. Such leading indicators include the following:
Stock Market
As stock prices are partially centered around companies expected earnings, the market can indicate the economy’s direction if earnings estimates are accurate.
In a strong market there are positive earnings expectations which can lead to an increase in stock prices signaling that the economy is preparing to thrive. Conversely, a weaker market can be represented by negative earnings expectations which may lead to a decrease in stock prices and a subsequent recession.
Despite being a leading indicator, the stock market is not the most important indicator given some flaws. Earnings estimates are not always accurate. The stock market can be manipulated via high-volume trading, complicated financial derivates, and creative accounting strategies to magnify revenue or downplay losses.
The stock market has also been inclined to creating “bubbles”, which sends the wrong signal in regards to where the market is heading or artificially portrays its current strength. Bubbles are created when investors ignore economic indicators and drive up the price of an asset irrespective to its inherent value.
Manufacturing Activity
Manufacturing activity is another indicator given its strong influence on gross domestic product. An increase in manufacturing implies a higher demand for goods which signals a healthy economy.
However, some goods produced may never find an end consumer so its important to also analyze retail sales data.
Inventory Levels
High inventory levels can mean that demand for inventory is anticipated on increasing or demand is simply lacking. In the instance that there is an increase in consumer activity, businesses with lots of inventory can meet demand thus becoming more profitable. In the event that demand is lacking high inventories translate to retail sales and consumer confidence are down and suggest that people are not spending on non-essential goods due to tough times or anticipating a future recession.
Retail Sales
Retail sales are a critical metric to as they are positively correlated with inventory levels and manufacturing activity. Strong retail sales equate to an increased GDP, which also strengthens an economy’s currency. As sales increase companies may employ more people to sell and manufacture products in turn giving consumers more money to spend.
A drawback to this metric is it doesn’t provide insight into how consumers are purchasing goods. If consumers are using credit cards and accumulating debt to acquire goods, this could signal a recession if debt cannot be repaid. An increase in retail typically represents an improving economy.
Building Permits
Building permits issued lends insight to future real estate supply levels. More permits indicate an active construction industry, leading to more jobs and an increase in GDP.
Similar to inventory levels in addition to looking at real estate supply levels it is also important to look purchasing & leasing activity in both commercial and residential real estate.
Real Estate Market
An environment of high real estate supply levels may lead to decreasing property values as there is not enough demand to keep prices at previous levels as they may be unaffordable to consumers or that real estate prices are inflated due to a bubble.
This situation directly increases homeowner wealth. It may also lead to a decrease in real estate industry related jobs thus increasing unemployment. property owners may not be able to afford property taxes therefore shrinking government resources.
Level of New Business Startups
The final core indicator of economic health is the number of new businesses emerging in the economy. Businesses hire employees thus lowering unemployment levels and positively contributing to GDP.
