Open any newspaper or catch up on the financial news on radio, television or online, and there’s no escaping them. The big index numbers, on jobs, prices, growth, housebuilding and the rest, loom over all economic and business news.
Economists and financial journalists pour over economic data, as the soothsayers of ancient Rome studied the flight of birds, to try to foretell the future. Economic indicators can, and frequently do, move markets, which is why most countries keep them under lock and key until the prearranged release time, to prevent insider dealing. But what are economic indicators and why do they matter?
To answer the first question, economic indicators are data, usually collected by public bodies, although there are exceptions, that relate to the performance of the economy. There are very many of them – to take one example, that of Britain’s Office for National Statistics, the available numbers include “UK manufacturers’ sales by product”, “House price statistics for small areas in England and Wales” and “Index of labour costs per hour, UK: January to March 2019”.
Worthwhile stuff, no doubt, but our focus is going to be on the economic indicators that make the headlines and turn dealing screens blue or red. Why are economic indicators important? In short, because markets say they are, and no trader can be without a grasp of the most significant.
In a sense, this is the master-indicator, the one from which all the others derive. Which is not to say it is unproblematic, as we shall see.
Most countries measure growth in two ways. One is gross domestic product (GDP), which adds up all the economic activity taking place within the territory in question – whether the US, UK, Japan or anywhere else – regardless of the nationality or location of the ultimate beneficiary, such as the German shareholders of a car factory in the US.
GDP was much in favour in the years running up to the crisis, as nationality was considered irrelevant in a globalised world. But more recently, with a return to protectionism, some believe the second measure, gross national product (GNP), is an equally important piece of economic data.
GNP, like GDP, looks at domestic economic activity but then deducts items such as our German-owned car factory and then adds in the earnings of British-owned foreign assets.
Why is this economic indicator important to traders? Essentially, because it ought to give some sense of where we are on the business and economic cycle. A run of very buoyant growth numbers would suggest the economy is somewhere near its peak, that a downturn is likely and that trading positions should be adjusted accordingly.
A run of weak numbers would suggest the opposite. But beware: growth figures are constantly being revised, sometimes substantially. Do not place too much reliance on them.
This one comes a close second in terms of economic indicators. Traders deal in money, and the inflation numbers tell you how rapidly money is losing its value. The best-known inflation indicators focus on consumer prices, such as those published in the US, UK and eurozone. But they do not tell the whole story.
A much more comprehensive measure, the GDP Deflator, shows how prices are moving across the whole economy. By definition, it takes longer to figure out, thus is published less frequently.
What can traders learn from inflation figures? As with growth, they give some idea of where we are on the economic cycle. They can also flag up likely changes in interest rates, given that rising inflation may prompt central banks to raise borrowing costs.
Low inflation, on the other hand, may presage a rate cut and other stimulus measures, so traders should look at their positions in that light.
This has become something of a misnomer in recent years in the US and Britain, given the
jobs boom on both sides of the Atlantic. But the name has stuck from the Seventies and Eighties, when joblessness, thought to have been banished in the post-war world, returned with a vengeance.
Traders should treat this economic indicator with care, for three reasons. One is that there is no single definition of unemployment even within countries, let alone among them. Some measures use eligibility for benefits as the criterion, others availability for work. None is perfect.
Another is that unemployment is a “lagging indicator” – it tells you where the economy has been, but not where it is going.
The third is that, rightly or wrongly, markets don’t necessarily react to unemployment figures as most people would. Bluntly, a rise in joblessness may not be seen as bad news if interpreted as a symptom of improving economic efficiency.
4. The balance of payments
Variously known also as the trade figures or the current account, these measure a country’s external position in terms of trade inflows and outflows. A standard balance of payments calculation would have four elements: trade in goods, trade in services, investment income and transfers.
This last category considers any movement of money in which nothing is purchased, whether it be foreign workers sending money home or a country’s United Nations membership fee.
In all four categories, inflows and outflows are netted off, and a figure is arrived at, either positive or negative. There was a time when a country running a big current account deficit would adjust policy to get back into surplus, but markets are more forgiving these days – the UK, for example, has run a deficit every year since 1984.
Why should traders follow the balance of payments numbers? Mainly because of their likely effect on the currency concerned. Poor current account figures may well put downward pressure on the currency and good figures see it rise.
5. Purchasing Managers’ Indices (PMI)
These are compiled by private-sector players across the world, sometimes trade bodies such as the Institute for Supply Management, sometimes by banks or other corporate bodies. As the title suggests, they measure opinion on the general outlook among business leaders, although these are more likely nowadays to be high-up executives than purchasing managers.
The results are then plotted on a scale running from one to 100, with 50 being the neutral point at which the state of opinion suggests the economy in question will neither expand nor contract. Below 50 suggests contraction and above 50 suggests expansion.
Why is this economic indicator important? Other traders and central bankers watch it closely, meaning it is hugely influential. But its scientific aura may give it an air of excessive authority.
What have we learned from these economic indicators? One lesson is that you can’t afford to ignore them and another is that none is infallible. Economic indicators are used in forecasting. But if all that is needed for successful investing and trading is to follow the economic data, we would all be rich.
And you don’t need to look at the statistics to know that we aren’t.