An economic indicator (or business indicator) is a statistic about the economy.

Economic
indicators allow analysis of economic performance and predictions of future performance.
One application of economic indicators is the study of business cycles.
Economic indicators include various indices, earnings reports, and economic summaries.
Examples: unemployment rate, quits rate, housing starts, Consumer Price Index (a measure
for inflation), Consumer Leverage Ratio, industrial production, bankruptcies, Gross Domestic
Product, broadband internet penetration, retail sales, stock market prices, money supply
changes.
The leading business cycle dating committee in the United States of America is the National
Bureau of Economic Research (private). The Bureau of Labor Statistics is the principal fact-
finding agency for the U.S. government in the field of labor economics and statistics. Other
producers of economic indicators includes the United States Census Bureau and United States
Bureau of Economic Analysis.
Economic indicators can be classified into three categories according to their usual timing in
relation to the business cycle:
• Leading indicators are indicators that usually change before the economy as a whole
changes. They are therefore useful as short-term predictors of the economy. Stock
market returns are a leading indicator: the stock market usually begins to decline
before the economy as a whole declines and usually begins to improve before the
general economy begins to recover from a slump.
• Lagging indicators are indicators that usually change after the economy as a whole
does. Typically the lag is a few quarters of a year. The unemployment rate is a lagging
indicator: employment tends to increase two or three quarters after an upturn in the
general economy.
• Coincident indicators are those which change at approximately the same time as the
whole economy, thereby providing information about the current state of the
economy. Personal income, GDP, industrial production and retail sales are coincident
indicators. A coincident index may be used to identify, after the fact, the dates of
peaks and troughs in the business cycle.[1]
There are also three terms that describe an economic indicator's direction relative to the
direction of the general economy:
• Procyclic indicators move in the same direction as the general economy: they
increase when the economy is doing well; decrease when it is doing badly. Gross
Domestic Product (GDP) is a procyclic indicator.
• Countercyclic indicators move in the opposite direction to the general economy. The
unemployment rate is countercyclic: it rises when the economy is decreasing.
• Acyclic indicators are those with little or no correlation to the business cycle: they
may rise or fall when the general economy is doing well, and may rise or fall when it
is not doing well.[2]
India economic indicators are important as they provide an accurate account of state Indian
economy at various points of time. There are various types of Indian economic indicators that
deal with different periods of time and there are others that deal with separate administrative

divisions like states for example. They are important in context of analyzing Indian
economy.

Gross domestic product of India

According to official information of financial year 2007, gross domestic product of India,
with regard to purchasing power parity, was $2.996 trillion and, with regard to official exchange
rate, it was $1.099 trillion. In financial year 2007, gross domestic product of India had

experienced a real growth rate of 9 percent.

In financial year 2007, per capita gross domestic product of India, with respect to purchasing
power parity, was $2,600. As of financial year 2007, 17.8 percent of India's gross domestic
product was contributed by agricultural sector and 29.4 percent came from industrial sector.
Services sector made maximum contribution of 52.8 percent in that financial year.

Rate of inflation in India

Rate of inflation in India is an important economic indicator. As of financial year 2008, projected
rate of inflation in India is lower than financial year 2007, when an inflation rate of 5.77
percent had been predicted. As per wholesale price index , rate of inflation in India was 8.75
percent in 2007.

Important Indian economic indicators

There are various types of economic indicators. They may be classified into following
categories:
• Month-wise selected economic indicators in India
• Economic position based on main indicators of Indian economy
• Selected economic indicators in India
• Market prices of selected commodities in India
• Indicators of social development in India
• State-wise selected socio-economic indicators in India
• Select debt indicators of central and state governments
• Macro-economic performance indicators
• Select fiscal indicators of central government
• Selected indicators of Indian economy
• Select fiscal indicators of state governments
• State-wise relative index of infrastructure in India
• Key indicators of Indian economy
• Plan-wise selected indicators of development in India
Economic Indicators: Overview

Economic indicators can have a huge impact on the market; therefore, knowing
how to interpret and analyze them is important for all investors. In this tutorial,
we'll cover some of the most important economic indicators. You'll learn where
to find them, how to read them and what they can tell you about he health of the
economy - and your investments.

http://www.investopedia.com/university/releases/default.asp

An economic indicator is simply any economic statistic, such as the

unemployment rate, GDP, or the inflation rate, which indicate how well the
economy is doing and how well the economy is going to do in the future. As
shown in the article "How Markets Use Information To Set Prices" investors use
all the information at their disposal to make decisions. If a set of economic
indicators suggest that the economy is going to do better or worse in the future
than they had previously expected, they may decide to change their investing
strategy.

To understand economic indicators, we must understand the ways in which economic

indicators differ. There are three major attributes each economic indicator has:
Three Attributes of Economic Indicators
1. Relation to the Business Cycle / Economy
Economic Indicators can have one of three different relationships to the economy:
1. Procyclic: A procyclic (or procyclical) economic indicator is one that moves
in the same direction as the economy. So if the economy is doing well, this
number is usually increasing, whereas if we're in a recession this indicator is
decreasing. The Gross Domestic Product (GDP) is an example of a procyclic
economic indicator.
2. Countercyclic: A countercyclic (or countercyclical) economic indicator is one
that moves in the opposite direction as the economy. The unemployment rate
gets larger as the economy gets worse so it is a countercyclic economic
indicator.
3. Acyclic: An acyclic economic indicator is one that has no relation to the health
of the economy and is generally of little use. The number of home runs the
Montreal Expos hit in a year generally has no relationship to the health of the
economy, so we could say it is an acyclic economic indicator.
2. Frequency of the Data
In most countries GDP figures are released quarterly (every three months) while the
unemployment rate is released monthly. Some economic indicators, such as the Dow
Jones Index, are available immediately and change every minute.
3. Timing
Economic Indicators can be leading, lagging, or coincident which indicates the timing
of their changes relative to how the economy as a whole changes.
Three Timing Types of Economic Indicators
1. Leading: Leading economic indicators are indicators which change before the
economy changes. Stock market returns are a leading indicator, as the stock
market usually begins to decline before the economy declines and they
improve before the economy begins to pull out of a recession. Leading
economic indicators are the most important type for investors as they help
predict what the economy will be like in the future.
2. Lagged: A lagged economic indicator is one that does not change direction
until a few quarters after the economy does. The unemployment rate is a
lagged economic indicator as unemployment tends to increase for 2 or 3
quarters after the economy starts to improve.
 3. Coincident: A coincident economic indicator is one that simply moves at the
same time the economy does. The Gross Domestic Product is a coincident
indicator.
Many different groups collect and publish economic indicators, but the most important
American collection of economic indicators is published by The United States Congress.
Their Economic Indicators are published monthly and are available for download in PDF and
TEXT formats. The indicators fall into seven broad categories:
1. Total Output, Income, and Spending
2. Employment, Unemployment, and Wages
3. Production and Business Activity
4. Prices
5. Money, Credit, and Security Markets
6. Federal Finance
7. International Statistics
Each of the statistics in these categories helps create a picture of the performance of the
economy and how the economy is likely to do in the future.
Total Output, Income, and Spending
These tend to be the most broad measures of economic performance and include such
statistics as:
• Gross Domestic Product (GDP) [quarterly]
• Real GDP [quarterly]
• Implicit Price Deflator for GDP [quarterly]
• Business Output [quarterly]
• National Income [quarterly]
• Consumption Expenditure [quarterly]
• Corporate Profits[quarterly]
• Real Gross Private Domestic Investment[quarterly]
The Gross Domestic Product is used to measure economic activity and thus is both
procyclical and a coincident economic indicator. The Implicit Price Deflator is a measure of
inflation. Inflation is procyclical as it tends to rise during booms and falls during periods of
economic weakness. Measures of inflation are also coincident indicators. Consumption and
consumer spending are also procyclical and coincident.
Employment, Unemployment, and Wages
These statistics cover how strong the labor market is and they include the following:
• The Unemployment Rate [monthly]
• Level of Civilian Employment[monthly]
• Average Weekly Hours, Hourly Earnings, and Weekly Earnings[monthly]
• Labor Productivity [quarterly]
The unemployment rate is a lagged, countercyclical statistic. The level of civilian
employment measures how many people are working so it is procyclic. Unlike the
unemployment rate it is a coincident economic indicator.
Production and Business Activity
These statistics cover how much businesses are producing and the level of new construction
in the economy:
• Industrial Production and Capacity Utilization [monthly]
• New Construction [monthly]
• New Private Housing and Vacancy Rates [monthly]
• Business Sales and Inventories [monthly]
• Manufacturers' Shipments, Inventories, and Orders [monthly]
Changes in business inventories is an important leading economic indicator as they indicate
changes in consumer demand. New construction including new home construction is another
procyclical leading indicator which is watched closely by investors. A slowdown in the
housing market during a boom often indicates that a recession is coming, whereas a rise in
the new housing market during a recession usually means that there are better times ahead.

Prices
This category includes both the prices consumers pay as well as the prices businesses pay for
raw materials and include:
• Producer Prices [monthly]
• Consumer Prices [monthly]
• Prices Received And Paid By Farmers [monthly]
These measures are all measures of changes in the price level and thus measure inflation.
Inflation is procyclical and a coincident economic indicator.
Money, Credit, and Security Markets
These statistics measure the amount of money in the economy as well as interest rates and
include:
• Money Stock (M1, M2, and M3) [monthly]
• Bank Credit at All Commercial Banks [monthly]
• Consumer Credit [monthly]
• Interest Rates and Bond Yields [weekly and monthly]
• Stock Prices and Yields [weekly and monthly]
Nominal interest rates are influenced by inflation, so like inflation they tend to be procyclical
and a coincident economic indicator. Stock market returns are also procyclical but they are a
leading indicator of economic performance.
Federal Finance
These are measures of government spending and government deficits and debts:
• Federal Receipts (Revenue)[yearly]
• Federal Outlays (Expenses) [yearly]
• Federal Debt [yearly]
Governments generally try to stimulate the economy during recessions and to do so they
increase spending without raising taxes. This causes both government spending and
government debt to rise during a recession, so they are countercyclical economic indicators.
They tend to be coincident to the business cycle.
International Trade
These are measure of how much the country is exporting and how much they are importing:
• Industrial Production and Consumer Prices of Major Industrial Countries
• U.S. International Trade In Goods and Services
• U.S. International Transactions
When times are good people tend to spend more money on both domestic and imported
goods. The level of exports tends not to change much during the business cycle. So the
balance of trade (or net exports) is countercyclical as imports outweigh exports during boom
periods. Measures of international trade tend to be coincident economic indicators.
While we cannot predict the future perfectly, economic indicators help us understand where
we are and where we are going. In the upcoming weeks I will be looking at individual
economic indicators to show how they interact with the economy and why they move in the
direction they do.
If you'd like to ask a question about economic indicators, economic growth, or any other
topic or comment on this story, please use the feedback form.

What are Economic Indicators?

This section answers questions such as "What are economic indicators?", "What do economic
indicators do?", "What are the various types of economic indicators?"
• A Beginner's Guide to Economic Indicators
• What is the Business Cycle?

Commodity Prices
An examination of what economic factors causes commodity prices to fluctuate and
conversely what impact fluctuating commodity prices have on the economy.
• What is a Commodity?
• Exchange Rates and Commodity Prices
• Can We Expect $100 Barrels of Oil in 2006? - Oil Futures Say No

Economic Growth and GDP

Information on the business cycle, what causes economies to grow in size... or shrink in size.
• What is the Business Cycle?
• The Baby Boom and the Future of the Economy
• Presidential Elections and the Economy
• What do the Economic Indicators Say About Dubya's Chances?
• Will Hurricane Katrina increase GDP?
• Does the Superbowl Predict Economic Growth?
• How Do You Measure the Size of the Economy?
• The Effect of Income Taxes on Economic Growth
• The Economic Effect of Tariffs
Exchange Rates
Information on how exchange rates are calculated, how exchange rates are determined and
what causes currencies such as the U.S. dollar, Euro, or Canadian dollar to fluctuate.
• Exchange Rates: What to Use as the Base?
• The Trade Deficit and Exchange Rates
• Exchange Rates and Commodity Prices
• Purchasing Power Parity: Link Between Exchange Rates and Inflation
• Is the Canadian Dollar Going Up in Value, or is the U.S. Dollar Going Down?
• Can We Expect the Canadian Dollar to Fall?
• How Does the Value of the U.S. Dollar Impact Canadian Businesses?
• The Canadian Exchange Rate
• Why Do Oil Prices and the Canadian Dollar Move Together?
• Is the Value of the Canadian Dollar related to Oil Prices?
• Will the Canadian Dollar Hit Par?
• Are Recent 2007 Movements in the Canadian Dollar Related to Oil Prices?
• The Performance of the U.S. Dollar in 2007
• Where can I get data on the Canadian Economy?

Inflation
Inflation is an increase in the price of a basket of goods and services that is representative of
the economy as a whole. The following links describe what causes inflation and what impact
inflation has on the economy.
• What is Inflation?
• Cost-Push Inflation vs. Demand-Pull Inflation
• Purchasing Power Parity: Link Between Exchange Rates and Inflation
• What is deflation and how can it be prevented?

Interest Rates
The interest rate is the yearly price charged by a lender to a borrower in order for the
borrower to obtain a loan. This is usually expressed as a percentage of the total amount
loaned. Interest rates, both nominal and real, have impacts on the economy as they impact the
saving, spending and investment decisions made by households and firms.
• What are Interest Rates?
• What Happens if Interest Rates Go To Zero?
• What Happens if Nominal Interest Rates Go To Zero?
• Calculating and Understanding Real Interest Rates
• What's the Difference Between all the Interest Rates in the Newspaper?
• Are U.S. Interest Rates Going to Continue to Rise?
Recessions and Depressions
There is an old joke among economists that states: A recession is when your neighbor loses
his job. A depression is when you lose your job. Learn more about recessions and depressions
with the links below.
• Recession? Depression? What's the difference?
• Do Changes in Stock Prices Cause Recessions?
• Why Do Government Budget Deficits Grow During Recessions?
• Why Don't Prices Decline During A Recession?
• Are recessions good for the economy?
• Globalization, Unemployment and Recessions. What is the Link?

Stock Prices
The value of stock market indicies seem to be the barometer many use for the health of the
economy.
• What does the value of the Dow Jones represent?
• When Stock Prices Go Down, Where Does the Money Go?
• Why Does a Stock Go Down in Price When There is a Big Sell Off?
• Do Changes in Stock Prices Cause Recessions?
• Does Wired's Page Count Predict NASDAQ Movements?
• Insider Trading: What did Martha Do?

Unemployment Rate
What are the causes of unemployment? What are the types of unemployment? What are
potential solutions to reduce the unemployment rate in an economy? Is unemployment always
a bad thing?
• Globalization, Unemployment and Recessions. What is the Link?
• Would 0% Unemployment Be a Good Thing?
• Has Employment Decreased Over The Last 25 Years?
• What is the Labor Force Participation Rate?

Money Supply
What is money? How much money is there in the United States? Should there be more
money? How does the size of the money supply impact economic variables such as inflation,
as well as economic growth?
• What is Money?
• How much is the per capita money supply in the U.S.?
• Why Not Just Print More Money?
• Why does money have value?
• Expansionary Monetary Policy vs. Contractionary Monetary Policy
• Why Does Money Have Value? - An Alternative Perspective
• What's the Future of Money?
• A Beginner's Guide to the Reserve Ratio
 • Are Credit Cards A Form Of Money?
• What is the Demand For Money?
• What Was The Gold Standard?

Government Spending
Government spending decisions impact both the amount of taxes we have to pay, but the
performance of the economy as a whole.
• Will Higher Taxes on Gasoline Lead to Higher Government Spending?
• Why Do Government Budget Deficits Grow During Recessions?
• How do we know that governments will not just spend the additional
revenue from

International Trade
International trade covers issues such as tarriffs, sanctions, and exchange rates. International
trade is praised by some and blamed by others for its impact on employment and the
economy.
• The Softwood Lumber Dispute
• Why Are Tariffs Preferable to Quotas?
• The Economic Effect of Tariffs
• The Trade Deficit and Exchange Rates
• Globalization, Unemployment and Recessions. What is the Link?
• What is the Current Account?
The India economic indicators are essential as they given an accurate status of India's
economy at different points of time. Various types of Indian economic indicators are used for
various periods of time. There are also indicators which are used for separate administrative
divisions such as states. These help us to analyze the Indian economy.

Gross Domestic Product of India

The gross domestic product (GDP) of India, according to purchasing power parity was US
$2.996 trillion in the financial year 2007. And in terms of official exchange rate, it was US
$1.099 trillion. There was a real growth rate of 9 percent in India's gross domestic product for
the financial year 2007.

Per capita gross domestic product (GDP) of India in terms of purchasing power parity in
the financial year 2007 was US $2,600. The agricultural sector contributed 17.2% of
India's gross domestic product; the industrial sector contributed 29.4% of the GDP while the
services sector contributed 53.7% of the GDP in the financial year 2008.

Rate of inflation in India

An important economic indicator is the rate of inflation. The rate of inflation (CPI) was 7.8%
for the year 2008. In 2007, the rate of inflation as per the wholesale price index was 8.75
percent.

Important Indian economic indicators

The different various types of economic indicators can be classified into various categories
such as -
 • Selected economic indicators month-wise
• The Economic position established on the main indicators of the economy
• Key indicators of Indian economy
• Plan-wise selected indicators of development in India
• social development indicators in India
• Socio-economic indicators for states in India
• Certain debt indicators of central and state governments
• Select state governments fiscal indicators
• State-wise relative index of infrastructure in India
• Macro-economic performance indicators
• Certain fiscal indicators of the central government
• Selected economic indicators in India
• Selected commodities market prices
• Selected indicators of Indian economy
Industrial growth
The industrial growth in December 2008 was 1.0 per cent for mining, -2.5 per cent for
manufacturing and 1.6 percent for the electricity sector. The revised annual growth for April-
December, 2008-09 for mining was 3.0 per cent, for manufacturing was 3.3 per cent and 2.7
per cent for the electricity sectors. There was lesser growth for capital goods and basic goods
in December, 2008.

Foreign Institutional Investors' FII

There were net investments by foreign institutional investors' (FIIs) to the tune of US$ 10
billion from April to September of 2009-10. Most of these investments have come from the
primary market. According to the Securities and Exchange Board of India (Sebi), FII net
investment was US$ 7.08 billion till 6 November 2006.

Foreign Direct Investment FDI

In July'09, the inflow of foreign direct investment (FDI) was US$ 3.5 billion according to Mr
Anand Sharma, the Commerce and Industry Minister. During April-July 2009, FDI equity
inflows receipts were US$ 10.532 billion. In June 2009, India attracted foreign direct
investment worth US$ 2.58 billion according to the Department of Industrial Policy and
Promotion (DIPP).

PDF

EMAIL
 PRINT

CURRENCY
CONVERTER

LARGER TYPE

SMALLER TYPE

TOOLS
Top of Form

DICTIONARY :

Bottom of Form
Top of Form

THESAURUS :

Bottom of Form

When the economy slows down and the market is on a downward trend,
it is not necessarily bad as this could be a golden opportunity to spot
some good stocks at a bargain

IF YOU have been following the

news on a daily basis, you surely
would have heard the repeated
news on the fall of the US and
European markets that are
currently spreading gloom across the globe.
With the risk of global recession on the increase, global stock markets are not left unscathed
by the predicament the world's economic giants are in. Stock markets worldwide are left to
face strong selling pressures that are wiping out their asset values.
As a result, you might be wondering whether your portfolio (albeit confined to the local
business environment) is strong enough to weather the adverse external shocks that are
causing jitters in markets across the globe.
Why do you need to understand and monitor the economic situation?
A company's earnings and future prospects depend largely on the overall business and
economic climate. No matter how strong a company's fundamental is, if the economy is
down, the performance of a company will inevitably be affected somewhat. Cyclical stocks
will probably face a larger impact compared to non-cyclical or defensive stocks.
Meanwhile, the stronger companies will be able to weather the harsh economic situation
better than the weaker or less well managed ones.
Therefore, as an investor, it is important for you to understand the macro picture of the
economy, not just the sector/industries or stock/company that you are interested in investing
in.
What is an economic indicator

An economic indicator is in simple terms, the official statistical data of a certain economic
factor that are published periodically by the government agencies, which an investor can use
to gauge the economic situation. It allows investors to analyze the past and current situation
and to project the future prospects of the economy.
There are three basic indicators that matter to investors in the stock market, namely inflation,
gross domestic product (GDP) and the labour market.
* Inflation
Inflation is important for all investments, simply because it determines the real rate of return
that you get from your investment. For instance, if the inflation rate is 5 per cent and the
nominal return is 8 per cent, this means that your real rate of return is 3 per cent as the 5 per
cent has been eaten by inflation.
Inflation's impact on the stock market is even more complicated. A company's profit will be
affected by higher inflation. Its input cost will increase and the impact of the increase will
depend on how much of the incremental cost the company is able to pass on to its consumers.
The amount that the company will have to absorb will reduce its profits, assuming all else
being equal.
The stock market will suffer further negative impact if it is accompanied by increased interest
rates as the bond market is seen as a cheaper investment vehicle compared to stocks. When
this happens, investors will sell off their stocks to invest in bonds instead.
The most commonly used indicator for the measurement of inflation is consumer price index
(CPI). It consists of a basket of goods and services commonly purchased by consumers, such
as food, housing, clothes, transportation, medical care and entertainment.
The total value of this basket of goods and services will be compared with the value of the
previous year and the percentage increase will be the inflation rate.
On the other hand, where the value drops, it will be a deflation rate. A steady or decreasing
trend will be favourable to the overall stock market performance.
* Gross Domestic Product
Another important indicator is the GDP measurement. It is the total value of goods and
services produced in a country during the period being measured. When compared to the
previous year's reading, the difference between these two readings indicates whether a
country's economy is growing or contracting. GDP is usually published quarterly.
When the GDP is positive, the overall stock market will react positively as there will be a
boost in investor confidence, encouraging them to invest more in the stock market. This will
in turn boost the performances of companies.
When the GDP contracts, consumers tread cautiously and reduce their spending. This in turn
will affect the performance of companies negatively, thus exerting more downward pressure
on the stock market.
* Labour market
The unemployment rate as a percentage of the total labour force will basically indicate the
country's economic state. During an economic meltdown, most companies will either freeze
hiring or in more severe cases downsize, by cutting costs and reducing capacity. When this
happens, the unemployment rate will increase, which in turn, creates a negative impact on
market sentiment.
Bottom line
By understanding the economic indicators, you should be able to gauge the current state of
economy and more importantly, the direction in which its headed. Pooling this knowledge
together with the detailed research on the companies that you are interested in, you should be
well equipped to make sound investment decisions.
Bear in mind that when the economy slows down and the market is on a downward trend, it is
not necessarily bad as this could be your golden opportunity to spot some good stocks at a
bargain that are worth buying
The Big Three Economic Indicators How Economic Factors Affect the Stock Market Jim
Graham 04/10/2004
Traders are always trying to understand the factors that cause the market to rise and fall. The
truth is that there are a multitude of factors, and millions of investors make decisions
that impact the market every day. Corporate earnings and news, political news, and
general market sentiment can all move the market. But economic factors have the most
influence on long-term market performance.
There is a lot of economic data available on the US economy, and almost every day some
economic report or another is being released. In my daily commentary, I always try to assess
the importance of each item, how it fits into the current economic situation, and often where
you can go to see the original source.
Of all the economic indicators, the three most significant to stock market investors are
inflation, gross domestic product (GDP), and labor market data. I try at all times to keep in
mind where these three are in relation to the current stage of the economic cycle. That then
allows me to estimate how any piece of economic data will affect these three indicators, and
then project its probable effect on the stock market.
INFLATION
Inflation is a significant indicator for securities markets because it determines how much of
the real value of an investment is being lost, and the rate of return you need to compensate
for that erosion. For example, if inflation is at 3% this year, and your investment also
increases by 3%, in real terms you have just managed to stay even. And to take on market
risk, most individuals require a “risk premium” above and beyond the inflation rate. So
investors who buy stocks do so expecting they will get a return equal to (or better than) that
risk premium adjusted by the inflation rate. So the higher the inflation rate, the higher
nominal return is needed for a stock price to remain the same.
But the effect inflation has on the stock market is even more complicated than that. The
main impact of inflation on stock prices actually comes from the effect it has on a company’s
earnings. Low inflation keeps a company’s costs down, and increases profits. So all other
things being equal, (a favorite phrase of all economists), low inflation is better for the market
than high inflation.
There are many causes of inflation. From a supply-demand standpoint, it can be due to
increased demand for a particular product, from an increase in a company’s cost of supplies,
or from limited supplies (like OPEC members restricting oil supplies), or even just due to
fear that supplies might be limited at some point in the future. But the single most important
determinant of inflation is the output gap, which is the balance between supply and demand
in the economy.
The output gap measures the difference between the economy’s potential, where all capital
and labor resources are in use, and the actual level of output. When actual output is below
its potential, inflation should be low because excess workers and unused plant and
equipment are available. The actual level of output is easy to get, and is measured by GDP.
But potential output is harder to get, requiring estimates to determine its value. So while the
output gap is important to always keep in mind when interpreting economic data, its exact
amount is never known. For that reason it is not a realistic indicator for investors to use, and
why a proxy is required, with the Consumer Price Index (CPI) the most widely followed
measure of inflation.
The Labor Department issues a CPI figure every month, measuring the increase in the price
of a given "basket" of goods and services purchased by the average consumer. That basket
supposedly includes a number of items commonly purchased by all or most consumers, such
as food, housing, clothes, transportation, medical care, and entertainment. The total value of
that basket is then compared to the same basket of goods a year later. The percentage
increase in the price for these goods in one year is the inflation rate (or if the value drops,
like in Japan recently, the deflation rate). That measured percentage, for instance 3%, means
that in general the basic necessities of life cost 3% more today than they did last year.
There are of course some problems with this measure as well. For one thing, the products
rarely remain exactly the same, and it is difficult to strip out how much of an increase is due
to inflation, and how much is due to other factors such as improvements in quality. Also, the
composition of what people buy changes over time. In fact, many of the goods now included
were not even invented 20 or 30 years ago. Still, it is the best proxy currently available, and
at least in the short- to medium-term, is the number that investors focus on when making
their decisions.
GROSS DOMESTIC PRODUCT
While GDP is an important component in inflation, it is also important as an economic
indicator in its own right. When compared to the previous year’s reading, it tells you how
fast the economy is growing (or contracting). GDP is the dollar value of all goods and
services produced by a given country during a certain period. It is measured by either adding
all of the income earned in an economy, or by all the spending in an economy. Both
measures should be roughly equal.
Gross domestic income includes wages and salaries, corporate profits, interest collected by
lenders, and taxes collected by governments. GDP domestic expenditures includes consumer
spending, housing investment, government spending, business spending (investment in
factories, equipment, and inventory), as well as foreign spending on our exports minus our
spending on their imports. With so many individual components affecting GDP (and
through the output gap, inflation) you can see how easy it is for the number of economic
reports to mushroom.
GDP affects the stock market through its effect on inflation, as well as through its use a key
indicator of economic activity and future economic prospects by investors. Any significant
change in the GDP, either up or down, can have a major effect on investing sentiment. If
investors believe the economy is improving (and corporate earnings along with it) they are
more likely to pay more for a given stock. If there is a decline in GDP (or investors expect a
decline) they would be willing to pay less for a given stock, leading to a decline in the stock
market.
Those who have made it through this far are probably familiar with an alternative view that
has been mentioned frequently in the news lately, that the stock market itself exerts a reverse
effect on economic activity, the so-called “wealth effect”. This theory says that a fall in the
stock market makes individual’s personal wealth (or perceived wealth) fall. They
consequently stop spending as much, and since consumer spending represents around two-
thirds of GDP, a small change in consumption exerts a significant effect on GDP. This
means that as the stock market falls, GDP also falls, which just further intensifies the
downward pressure on the stock market.
THE LABOR MARKET
The final major factor influencing the economy is the labor market. The key indicators most
investors focus on are total employment and the unemployment rate. US citizens who are
already working represent the employed, while those who are actively looking for work, but
haven’t found it yet, are the unemployed. The unemployment rate does not include people
without jobs who are not looking for jobs, such a retirees or just people who are discouraged
and have given up trying to find a job.
The Employment Report is published monthly by the US Department of Labor, and provides
both the employment and unemployment numbers. There is always some unemployment.
As the allocation of resources change in the economy, based on what people are buying,
some companies go out of business while others that produce the things now in demand will
be expanding. This causes a flow of labor from losing to winning industries, and it is not an
instantaneous process. Others may leave their jobs by choice. This means there is always
some amount of unemployment built into our economic structure, what is often termed the
“natural” level of unemployment.
The natural level of unemployment is that point where any drop below that figure creates
conditions that will drive up inflation. There is always some disagreement as to what the
“natural” level of unemployment is for the US economy. For one thing, it changes over time
as the nature of the economy changes. For most of the 1980’s, it was often estimated at
about 6%, although most economists now feel it is probably around 5%, or even the high
4’s.
What might cause this kind of change? A paper a couple years ago from the Brookings
Institute cited some factors that they estimated have reduced the natural rate by about 1%.
Accounting for about 0.4% is the aging of the population; older people tend to be more fully
employed. The growth of temporary staffing firms that rapidly match job-seekers with
employers could account for 0.2-0.4%. Finally, the doubling of the prison population
probably accounts for about 0.2%, by removing from the labor force people who are less
likely to be employed.
CONCLUSION: PUTTING IT ALL TOGETHER
There are many components that come together to calculate each of the major economic
indicators, and unfortunately they all rarely point in the same direction. In addition, each of
these indicators are closely linked to one another. That is what makes it difficult to interpret
the likely result from any individual economic report. To make things even more difficult,
whether a certain piece of news is good or bad depends on what part of the cycle the
economy is at.
To further complicate things, there are many institutions and safeguards within an economy
that are designed to mitigate or increase any of these effects. Their probable reaction to
news and events must be factored into any predictions for the future behavior of the
economy. Monetary policy and fiscal policy are two primary ways that government bodies
influence the economy. Certainly listening to Alan Greenspan, and trying to predict future
moves by the Federal Reserve, keep more than one economist employed. And actions taken
by the Federal Open Market Committee do often move the stock market.
The economic evidence right now seems to indicate that the current output gap is quite large,
with plenty of room for expansion without inflation. Therefore reports showing an increase
in GDP, or unemployment decreasing, are good news and the market should go up. Any
report that shows inflation is higher than expected is bad, because it may indicate that we are
overestimating the size of the output gap, and should cause the stock market to drop. But in
a later stage of the economic cycle, when the output gap is smaller or non-existent, those
same news items would have the opposite effect on the market.
Let’s work through one last example and explain the chain of reasoning leads to what may
seem on the surface a counterintuitive result, showing how a report that unemployment is
low might be bad for the market. Because the paradox of labor market data, at least as it
relates to the stock market, is that when the unemployment rate is low the stock market is
usually expected to go down. The more people that are employed, the more consumer
spending will increase, which leads to an increase in GDP. So far, so good. But as we saw
earlier, when GDP increases, that means the output gap will decrease, which means the
economy stands a greater risk of inflation. And inflation is bad for the stock market. So it
goes down.
Inflation, GDP, and employment data all exert significant influence on the stock market. All
three are closely interrelated and a change in any single factor can have a significant trickle-
down effect. That is why I try to make sure when I write my daily commentary that I
explain how important (I feel) a report is and how I interpret it in light of current economic
conditions. And since interpretation is as much an art as science, I often try to point you to
the original source documents, so that you can take a quick look at the data, if only to see
what the headlines, business articles, and I am leaving out.

Understanding the Effects of Critical Economic

Indicators on the Stock Market (Part I)
print Send to friend Rate This article

Nam
e

Emai
l

Frie
nd's
Nam
e
Frie
nd's
Emai
l

Send

Did you find this

article useful?

Yes | No

Comment:

Submit

View Result

If you have been following the news on a daily basis, you

surely would have heard the repeated news on the fall of the
US and European markets that are currently spreading
across the globe. With the risk of global recession on the
incline, global stock markets are not left unscathed by the
predicament the world’s economic giants are in. Stock
markets worldwide are left to face strong selling pressures
that are wiping out their asset values. Underpinned by such
scenario, you would be wondering whether your portfolio
(albeit confined to the local business environment) is strong
enough to weather the adverse external shocks that are
causing jitters in markets across the globe?
Why do you need to understand and monitor the
economic situation?
A company’s earnings and future prospects depend largely
on the overall business and economic climate. No matter
how strong a company’s fundamental is, if the economy is
down, the performance of a company will inevitably be
affected to a certain extent. Cyclical stocks will probably
face a larger impact compared to non-cyclical or defensive
stocks. Meanwhile, the stronger companies will be able to
weather the harsh economic situation compared to the
weaker ones. Therefore, as an investor, it is important for
one to understand the macro picture of the economy, not
just the sector/industries or stock/company that one is
interested in investing.
What is an economic indicator?
An economic indicator is in simple terms, the official
statistical data of a certain economic factor that are
published periodically by the government agencies, that
investor can use to gauge the economic situation. It allows
the investors to analyze the past and current situation, and
to project the future prospects of the economy. There are
three basic indicators that are significant to the investors in
the stock market, namely inflation, GDP (gross domestic
products) and the labor market.
Inflation
Inflation is important to all investments, simply because it
determines the real rate of return that you get from your
investment. For instance, if the inflation rate is 5% and the
nominal return is 8%, this means that your real rate of
return is 3% as the 5% has been eaten by inflation.
Inflation’s impact on the stock market is even more
complicated. A company’s profit will be impacted with
higher inflation. Its input cost will increase and the rate of
increase would depend on how much of the incremental
cost the company is able to pass on to its consumers. The
amount that the company will have to absorb will reduce its
profits, assuming all else being equal. The stock market will
suffer further negative impact if it is accompanied by
increased interest rate as bond market is seen as a cheaper
investment vehicle compared to stocks. When this
happens,investors will sell off their stocks to invest in bonds
instead.
The most commonly used indicator for the measurement of
inflation is CPI (consumer price index). It consists of a
basket of goods and services commonly purchased by
consumers, such as food, housing, clothes, transportation,
medical care and entertainment. The total value of this
basket of goods and services will be compared to the value
of the prior year and the percentage increase will be the
inflation rate. On the other hand, where the value drops, it
will be a deflation rate. A steady or decreasing trend will be
favorable to the overall stock market performance.
GDP (Gross Domestic Product)
Another important indicator is the GDP measurement. It is
the total value of goods and services produced in a country
during the period being measured. When compared to the
previous year’s reading, the difference between these two
readings indicates whether a country’s economy is growing
or contracting. GDP is usually published quarterly.
When the GDP is positive, the overall stock market will
react positively as there will be a boost in investor
confidence, encouraging them to invest more in the stock
market. This will in turn boost the performances of
companies. When the GDP contracts, consumers would
tread cautiously and reduce their spending. This in turn will
affect the performance of companies negatively, thus, more
downward pressure will be exerted on the stock market.
Labor market
The unemployment rate as a percentage of the total labor
force will basically indicate the country’s economic state.
During an economic meltdown, most companies will either
freeze hiring or, in more severe cases downsize, by
alleviating cost and reducing capacity. When this happens,
the unemployment rate will increase, which in turn, creates
a negative impact on the market sentiment.
Bottom line
By understanding the economic indicators, you should be
able to gauge the current state of economy and more
importantly, the direction in which its headed. Pooling this
knowledge together with the detailed research on the
companies that you are interested in, you should be well
equipped to make sound investment decisions. Bear in mind
that when the economy slows down and the market is on a
downward trend, it is not necessarily bad as this could be
your golden opportunity to spot some good stocks at a
bargain that are worth buying.