An Economic indicator is any statistic about the economy which investors use in order to interpret and understand the current and future health of the economy. A variety of data figures are closely tracked by investors and analysts in order to predict investment opportunities. Mostly these data figures are regularly released and are classified on the basis of Leading Economic Indicators and Lagging Economic Indicators.
Leading economic indicators are indicators which change before the economy changes. They are very useful at a time when the economy is reversing a trend – either coming out of a recession or heading into one. Key examples of leading economic indicators: Stock Market Returns, data pertaining to Manufacturing Activity (such as industrial production data) and Foreign Institutional Investment (FII data) etc. In addition, data pertaining to retail sales, housing sales etc., are all leading economic indicators and are closely tracked in developed economies such as the U.S. and EU countries. Due to the lack of availability and authenticity of such data in India, they are not closely monitored or relied upon.
Lagging economic indicators are indicators which tend to change after the economy changes. In other words, they trail the economy and do not change direction until a few quarters after the economy changes direction. Key examples of lagging economic indicators: Gross Domestic Product (GDP data), Inflation, Interest Rates, Unemployment Rate and Income & Wealth.
Key Leading Economic Indicators
Stock Market Returns: Stock market returns are a leading economic indicator, as the stock market usually begins to decline before the economy declines and begins to improve before the economy begins to pull out of a recession. This is premised on the assumption that (current) stock prices reflect expected future corporate earnings growth, which in turn is related to future GDP growth.
Also see a bigger discussion on this: Stock Market vs. Economy: Is there a relation at all?
Manufacturing Activity: Manufacturing activity is another leading economic indicator of the state of the economy. A rise in the manufacturing activity of materials indicates a rising demand for consumer goods which is a sign of GDP growth. Further, this creates employment as more workers are employed in the manufacturing sector. This new employment results in more wages being paid all of which drives consumption. In India, the Index of Industrial Production (IIP) data is released on a monthly basis to indicate the level of manufacturing activity in the economy. You can visit here to view the current IIP data.
Foreign Institutional Investments (FII) and Foreign Direct Investment (FDI) are leading economic indicators which greatly influence the sentiment particularly that of the stock market and of the general economy as a whole.
FIIs: FIIs are foreign entities which are allowed to invest in the Indian share markets and are a major sources of liquidity for the markets. FII money is often termed as ‘hot money’ because FIIs are allowed to buy and sell just like other domestic investors (up to a certain level). When FIIs invest large amounts in the Indian share markets, it is seen as a seal of approval by sophisticated investors who back themself with detailed diligence and study of the future prospects of the economy. For this reason their buying indicates a positive economic outlook and vice-versa. For latest statistics on FII activity visit here.
FDI: FDI which is a direct investment into the country from an entity in another country, either by setting up a new company or by way of a merger or acquisition etc., also indicates the positive sentiment of overseas investors. To view the latest FDI investments into India, you can visit here
Key Lagging Indicators
Gross Domestic Product (GDP): National output or GDP is the most important concept of macroeconomics. When GDP increases, it is a sign that the economy is getting stronger. While a reduction in the GDP indicates a state of weakening economy.
Note: While GDP is a lagging economic indicator, everytime the GDP data gets published, the stock markets react to it. Why? This is because a lot of buying and selling in the stock market happens based on forecasting of the future. Analysts forecast the GDP data in advance. A below forecast GDP figure indicates that the economy did not grow as analysts had been expecting it to. On the other hand a higher than forecasted GDP data would tend to indicate strengthening economic activity.
WPI measures the price of a representative basket of wholesale goods including food articles, LPG, petrol, cement, metals, and a variety of other goods. Inflation is determined by measuring in percentage terms the total increase in the cost of the the total basket of goods over a period of time. For a list of what is included in the WPI basket you can view this sample report.
Interest Rate: Interest rates act as a vital tool of monetary policy when dealing with variables like investment, inflation, and unemployment. The Central Bank (RBI) reduces interest rates when it wants to increase investment and consumption in the economy. Reduced interest rates make it easier for people to borrow in order to buy goods and services such as cars, homes and other consumer goods. At the same time, lower interest rates can lead to inflation. When the Central Bank wants to control inflation, it increases the rate of lending. Banks and other lenders are then required to pay a higher interest rate to the Central Bank in order to obtain money. They pass this on to their customers by charging a higher rate of interest for lending money. This reduces the availability of money in the economy and helps in controlling inflation.
Note: A helpful link to check the official GDP, Inflation and Interest Rate data: Click here
Also note that RBI site is not frequently updated. We update the GDP, Inflation and Interest Rate data in real time on our site at: Click here
Unemployment Rate: The unemployment rate indicates the number of people from the available pool of labour (i.e. the labour force of the nation) who are unable to find work at any given point in time. When unemployment is high, consumers have less money to spend, which has a negative impact on the overall GDP as demand and consequently the production for goods and services declines.
In India, the unemployment data numbers are only reported once in 5 years. Given the lack of social security in India, and the vastness of our population, it is difficult to ascertain the total number of people who are gainfully employed in India at any given point of time. Hence, domestic unemployment data is not very closely watched in India. Ironically, the US Jobs data has a bigger impact on Indian stock markets primarily because any improvement or deterioration in high consumption markets of the west set the trend for global economic recovery.
Income and Wealth: Income is the amount of money or its equivalent received during a period of time in exchange for labor or services, or received from the sale of goods or property, or received from financial investments as dividends, profit, interest etc.
About the Author
Rajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.Follow @SanaSecurities