The month of January is named after the Roman god Janus, who was imagined as having two faces: one looking toward the past, the other looking toward the future. In a similar manner, economists like to look in both directions to better understand economic trends. But instead of two faces, they use economic measures called “indicators.”
The most commonly studied indicators are tracked by The Conference Board, which publishes composite indexes of leading, lagging, and coincident indicators (see chart). These indexes are designed to more clearly summarize and reveal economic patterns and turning points by smoothing out the volatility of individual components.1
Reading Tea Leaves?
Not surprisingly, leading indicators garner the most attention because they may forecast the future direction of the economy. The Conference Board Leading Economic Index® includes 10 components: weekly hours for manufacturing workers, initial unemployment insurance claims, consumer expectations for business conditions, stock prices, credit activity, interest-rate spread, building permits, and three separate measures of manufacturers’ new orders.2
Some economists also consider more unusual trends. For example, former Federal Reserve Chairman Alan Greenspan thought that sales of men’s underwear could be a leading indicator because underwear is among the first purchases that men postpone when times are tough. The “lipstick index” was coined to explain why sales of lipstick (later expanded to nail polish and cosmetics) increased during an economic downturn when women would buy relatively affordable treats rather than expensive luxuries. On a more serious level, sales of scrap metal and cardboard boxes can be viewed as leading indicators because they are used for industrial production and to ship manufactured goods.3–4
Confirming the Past and Present
Lagging economic indicators can help confirm that an economic trend is already in place, but they are not helpful in forecasting the future. For example, as has been evidenced over the last six years, unemployment tends to rise after a recession has already begun, and it may take months or years of recovery before the unemployment rate begins to fall.5 The Conference Board Lagging Economic Index® includes duration of unemployment, the ratio of inventories to sales, labor costs in relation to manufacturing output, the prime interest rate, outstanding commercial and industrial loans, and the consumer price index for services.6
Coincident indicators, which generally move in step with the broader economy, may also offer confirmation that the economy is moving in a particular direction. The Conference Board Coincident Economic Index® tracks employment (employees on nonagricultural payrolls), personal income, industrial production, and manufacturing and trade sales.7
Economic indicators may offer helpful clues about the direction of the economy, but economists require extensive training and experience to interpret them. Be careful when making any investment decision based on these indicators, and be sure to consider your long-term financial strategy.
1–2, 6–7) The Conference Board, 2013
3) usnews.com, February 13, 2012
4) SeekingAlpha.com, June 10, 2013
5) U.S. Bureau of Labor Statistics, 2013
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