You can read economic data daily, but not all economic data is equal in forecasting the future of the economy. Indicators that identify emerging trends are known as leading indicators.
For example, manufacturer’s new orders for capital goods provides an estimate for overall business investment activity. An increase, as the one in April of this year, in this indicator implies business activity may have stabilized going forward, although on a historical basis it remains low. A group of leading indicators of the Conference Board’s Leading Economic Index includes data from a wide variety of sectors in the economy, including consumer expectations, manufacturing and financial markets.
For every recession since the 1950s, the percentage of leading indicators within the index rising during the previous six months prior to a recession were two or fewer out of 10.
Additionally, most indicators rise in anticipation or concurrently with subsequent recoveries. Because stock markets anticipate recoveries and rally, gains usually occur before all leading indicators have moved upward and in itself is a leading indicator.
It is important for investors to watch, however, many indicators as no two recessions are exactly alike. In this one, the massive losses of financial firms due to the housing credit crisis overwhelmed the Fed’s lowering interest rates and their increasing of the money supply.
Although a steep yield curve (when short-term rates are lowered by the Fed so they are lower than longer term rates), has been obtained, it only helps, but does not completely stabilize the financial system from the crisis level of several months ago.
After March, the stock market rallied more than 30 percent during the two following months. As any indicator can be impacted by outside factors from weather to terrorism, examination of many indicator trends are of importance when investing. Taken together, the present indicators imply the worst may be over and that the economy may stabilize earlier than expected.
While these signs of stabilization helped fuel the recent stock market rally, investors will be looking for sustained improvement in these indicators to confirm a bottoming of the economy.
Of course, there are no guarantees regarding the magnitude of any potential economic recovery. Historical analysis of leading indicators shows that owning stocks in the early stage of an economic upturn often has led to favorable results.
Investors should be wary of waiting for all indicators to turn positive because this usually occurred historically beyond the end of recessions and after much of the stock market gains have been made.
Indexes are unmanaged and investors are not able to invest directly into any index. Indexes do not incur management fees, costs or expenses. Investing in securities involves risk, including the potential loss of principal invested. With any investment vehicle, past performance is not a guarantee of future results.
Lea Smith Johnson, a financial adviser for FSC Securities Corp., 4515 Barracuda Drive, Bradenton, can be reached (941) 755-0975 or (941) 742-2731.