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Indicators within the Economic Cycle
Leading (Cyclical) Indicators
Leading indicators are commonly referred to as cyclical indicators. They help economists to measure the economic cycle. They are significant because they can be useful tools for short-term predictions of how well economic activity is doing within a nation.
A leading indicator is a measurable economic piece of data that changes its trend before the economy starts to change or enter a new trend. They are used to help predict changes in the economy before the data proves a change has already occurred. But caution should be taken because they are not always perfectly accurate in real-world applications.
Leading indicators are used to gain clarity on which way the health of the economy is potentially headed. Some of the ways are as follows:
- Investors use them to adjust their strategy to benefit from future market conditions.
- Federal policymakers use them when they are considering adjustments to monetary policy.
- Businesses use them to anticipate economic conditions that could potentially affect their revenues.
In practice, leading indicators are not always accurate predictors of the future but when used in conjunction with other data, they can reveal certain trends which support the probability of changing economic conditions.
Leading indicators include items such as:
- Interest rates
- Business confidence surveys
- Stock share prices
- Housing starts
- Consumer credit
- Car sales
- Manufacturing orders
Stock share prices are a leading indicator because the stock market will always attempt to prices in positive or negative economic conditions roughly 3-6 months in advance. Note, all markets are filled with speculators trying to get in on the action as soon as possible so that they can make as much money as possible. This is what makes all markets discounting mechanisms.
Another example is if the rate at which people are purchasing cars starts to drop then this could be a warning sign that people are worried about their jobs or have less money to purchase big-ticket items. This could be a warning sign of a pending downturn or slowdown in the economy. If car sales start to climb then we know that consumers have more money to spend which tells us earnings are potentially rising. We can see this in durable goods data before we actually see an uptick in the average hourly earnings data. This is all useful information to use in determining where the economy is potentially within the cycle.
Coincident Indicators
Coincident indicators help establish a reference point of where we are in the overall economic cycle because they focus on where the economy is currently right now. It’s a metric which shows the current state of economic activity within a particular area or subsection of the economy.
Coincident indicators are important because they show economists and policymakers the current state of the economy.
Coincident indicators include:
- Employment
- Real earnings
- Average weekly hours worked in manufacturing
- The unemployment rate
- Gross Domestic Product
Lagging Indicators
A lagging indicator is a measurable economic factor that changes after the economy has already begun to follow a particular pattern or trend. By their very definition a lagging indicator is not something that can be used to predict where the economy is heading into the future. It’s often a technical indicator that trails the price action of an underlying asset.
Economists and bank traders use lagging indicators as a way to "confirm" the strength or weakness of a given trend within the economy. Its only real value to us as retail traders is to use it as a confirmation tool of what we already know to be true. It never hurts to reinforce our bias with real information.
Since these indicators lag the prices of the asset, a significant move in the market generally occurs long before the indicator can provide any useful information. They confirm the existence of long-term trends but they do not predict them in any way and as such should only be used as a confirmation for a trend in the economy.
Lagging indicators are things such as:
- Manufacturing capacity utilization
- Job vacancies
- Average earnings
- Labour costs
- Productivity
- Unemployment
- Investment
- Order backlogs
- Stockpiles of consumable goods
Indicator Wrap Up
So, we can sum all this up by saying that
- Leading indicators turn 3-12 months before GDP
- Coincident indicators turn with GDP
- Lagging indicators turn 3-12 months after GDP
This is the historical average but these days’ things are moving so much faster than they used to so it would be wise to think 3-6 months or even earlier if the pace of the economic movement warrants it.
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