An economic indicator is any statistic that allows us to analyse how the economy is performing or is likely to perform in future. Indicators are often used for monitoring the business cycle – ie, the shorter-term shifts in economic growth around its long-term trend caused by periods of boom (in which the economy is expanding) and recession (in which it is contracting).
A single business cycle is a period of time that includes a boom followed a recession. Identifying the point when the boom is turning to bust should be extremely useful for investors – but this is very difficult to do consistently.
Indicators are classified in three main ways. They may be procyclical (increase or decrease in line with the wider economy), countercyclical (move in the opposite direction to the economy) or acyclical (no consistent relationship with the direction of the economy). Those that are correlated with the economy may be leading, coincident or lagging, depending on whether they usually change before, during or after the business cycle.
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The most important for an investor’s purpose are leading indicators. No leading indicator has a perfect record and the most useful ones vary between countries due to differences in the structure of the economy and to what data is gathered. However, data such as new manufacturing orders, new housing starts, retail sales and car sales are often helpful. A composite leading indicator (CLI), such as those compiled by the OECD, tries to combine several leading indicators into a single index that has more consistent predictive power than any one individual indicator.
Job-related data – such as unemployment and wages – are mostly lagging indicators, despite analysts often citing them as evidence that a boom is still robust. That’s because employers tend not to fire workers until a recession is well under way or hire new ones until the recovery is evident.
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