Economic indicators give clues to market direction

by Timothy M. Reese

for the Business Journal

Investors look to economic indicators key statistics showing the direction of the economy as clues to what may be ahead for the stock and bond markets. In general, economic indicators reflect the rate of economic growth and inflation.

Low inflation is usually good for financial markets, but high inflation can be detrimental to both stocks and bonds because the Federal Reserve, the nation's central bank, often responds to inflationary pressures by raising key interest rates. Higher interest rates tend to depress stock and bond prices while lower rates usually boost prices.

Economic reports don't always impact financial markets as you might expect. For example, low inflation is good for the markets. But, if the inflation news is not as benign as expected, financial asset prices could decline on the disappointing news.

As a rule, it's not whether inflation is high or low, it's whether inflation (or any economic news) is more or less than expected that moves the market.

Now that you have some background on the influence of economic indicators on the financial markets, let's take a look at some of the more common indicators.

Consumer price index. This index is an indicator of the general level of prices. Components include energy, food and beverages, housing, apparel, transportation, medical care and entertainment. When the index goes up, prices are rising. Inflation exists when the index rises consistently over a long period of time.

Unemployment rate. This is the percentage of the civilian labor force currently unemployed. If unemployment figures are higher, it indicates a lack of expansion within the economy, and the Federal Reserve might lower interest rates. Conversely, a big gain in the employment rate would be a reason for the Fed to hold rates steady or possibly raise rates if inflation is developing.

Gross domestic product. The gross domestic product is the broadest measure of the nation's production. It measures the market value of all newly produced goods and services in the United States. When the GDP is rising, the economy is growing. When the GDP is declining, the economy is in recession. To counteract a recession, the Fed may attempt to stimulate the economy by lowering interest rates.

Durable goods orders. This indicator gives a reading on the country's future manufacturing activity. Durable goods include those manufactured items with a normal life expectancy of three years or longer.

An increase in factory orders may indicate an expansion in the economy.

Leading economic indicators. This index is a composite of 10 statistics designed to foretell economic activity six to nine months in the future. Examples include building permits and new orders for consumer goods and materials.

Knowing the definitions of these indicators can help you better understand how the economy affects the financial markets and your investments.

However, be careful not to make hasty changes in your portfolio based on what a particular indicator shows.

History suggests that the best approach to investing is to focus on your long-term financial goals, not reacting to market swings caused by short-term economic news.

(The preceding article was provided by Timothy M. Reese, vice president, investments, with A.G. Edwards & Sons Inc., Member SIPC.)

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