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If interpreted correctly, economic indicators can help investors decide what stocks to buy, or sell, and when to trade. Here’s a quick guide to economic indicators.

Economic indicators are the dashboard of the investment world. Together they can give investors an idea of the speed and direction of economies and industries in the immediate past and potentially in the future.

Not all schools of thought rely on studying such indicators. Momentum investing – buying winners and selling losers – more or less ignores them. However, fundamental analysis takes them very seriously, as clues for when to trade what stocks. They may be leading, lagging or coincident indicators.

A leading indicator is an economic factor that changes in advance of the economy – though, like most things in economics, the connection is never guaranteed. Purchasing managers indices, which show how industrial procurement is rising or falling, give advance warning of changes in the economy, for example. If an industry is stocking up, it means it has production orders in the pipeline, feeding through into overall economic growth figures. So when the Markit/CIPS Purchasing Managers’ Index for the UK construction sector rose in May for the third month in a row, hitting its highest level since September 2007, that was a positive leading indicator for construction and hence the economy.

Lagging indicators affirm a change that has already taken place. Unemployment rises in the wake of economic decline. So, even though the UK economy grew by 0.3% in the first quarter of 2010, unemployment still rose 0.2% from the previous quarter to 8%. Companies want to be sure that recovery is really here before they start hiring again, so employment figures trail the direction of the economy by generally six months to a year.

Coincident indicators tell us what is going on right now. So, a rise in personal income accompanies economic growth. Production output is a real time indication of the state of the economy, tending to move in line with economic growth.

Some economists have identified more oblique indicators. Singapore is an important exporter to the rest of the world and its equity market tends to be sensitive to global market growth. So some believe that when Singaporean stocks rise faster than other markets they are signalling – acting as a leading indicator of – higher growth to come in the US and Europe. Likewise, Japan uses a lot of oil, so when Japanese stocks outpace other markets, it portends a rise in the oil price.

These are some other widely watched indicators:

Inflation
One of the most commonly used measures of inflation is the Consumer Prices Index, which tracks the prices of a representative sample of goods and services, and usually lags economic growth. Economic growth leads to higher employment, higher wages and higher consumer demand, which over time leads to higher prices (see “What price inflation”).

House prices
House price indices, such as those published by the Halifax and Nationwide, are lagging indicators of economic growth. As a measure of demand, they trail changes in general prosperity – decisions to buy and sell houses are not made quickly.

GDP
Gross domestic product is the annual value of all goods and services produced by a country and it is the benchmark for national economic growth or decline. A higher growth rate may be a leading indicator for inflation, as more consumer demand pushes up prices, and hence higher interest rates. A lower rate signals a slowdown in the economy, which could raise unemployment and reduce consumer spending.

Balance of payments
Balance of payments (BoP) figures record whether a country is exporting more than it is importing (a positive BoP) and how much foreigners are investing in its industry and markets. They record whether a country is experiencing net inflows or outflows of money. They are published after the fact and so lag improvements or declines in trade and investment.

The value of investments and the income from them may go down as well as up and you may not get back your original investment. Past performance is not a guide to future performance. The views expressed are Gartmore's views and must not be taken as an offer to buy or sell units or shares in the markets mentioned. These views are provided for information purposes only. The views expressed are as at 24 June 2010 and are subject to change.

• This entry was posted on: Wednesday, 30 June 2010 08:30 BST
• Filed under: Economics
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