Key economic Indicators: Leading, Lagging, Concurrent

29th June 2021 0 By indiafreenotes

Leading Indicators

Leading indicators are a heads-up for economists and investors who hope to anticipate trends. Bond yields are thought to be a good leading indicator of the stock market because bond traders anticipate and speculate about trends in the economy. However, they are still indicators, and are not always correct.

These indicators generally signal changes before changes actually occur in the economy. However, few leading indicators anticipate both expansions and recessions well. Examples of leading indicators include the New Residential Construction report (excellent for identifying a future expansion), the Consumer Sentiment Index (good for identifying an upcoming recession), and the PMI (formerly known as the Purchasing Managers’ Index and a well-rounded indicator for identifying both expansion and contraction).

  • Confidence index

Consumer confidence measures the degree of confidence of consumers on the state of the economy. If consumer confidence is high, they would spend and make more purchases adding to strong aggregate demand and economic growth.

Low confidence would suggest that consumers prefer to save and spend less, indicating a fall in consumption expenditure. Similarly, business confidence measures the optimism of businesses regarding economic strength.

  • Durable goods consumption

Durable goods are those goods that have a longer life, and high economic value. They represent a significant portion of the total retail consumption expenditure. Some examples of durable goods are furniture, jewellery, automobiles etc.

  • Yield curve

Yields are the interest rates of bonds traded in the market. The sovereign yield curve is a graphical representation of the interest rates of government bonds with different maturities. It describes the relation between short term interest rates and long term rates and inherently captures the market’s expectation of future interest rates.

  • Capacity Utilization

Capacity utilization is an indicator of slack in the manufacturing sector provides insights into the state of the business cycle. In other words, it tells us as to what extent the production capacity in the economy is idle or used. It is measured as a proportion of the actual output produced to that of potential output which can be produced with the installed capacity.

  • Bank Credit growth

Bank credit refers to the lending of funds by scheduled commercial banks (SCB) to various sectors in the economy. Non-food credit forms a bulk of the total credit and comprises loan given to different sectors (Industry, Agriculture and services) along with personal loans to individuals.

Lagging Indicators

Lagging indicators can only be known after the event, but that doesn’t make them useless. They can clarify and confirm a pattern that is occurring over time. The unemployment rate is one of the most reliable lagging indicators. If the unemployment rate rose last month and the month before, it indicates that the overall economy has been doing poorly and may well continue to do poorly.

The Consumer Price Index (CPI), which measures changes in the inflation rate, is another closely watched lagging indicator. There are few events that cause more economic ripple effects than price increases. Both the overall number and prices in key industries like fuel or medical costs are of interest.

Changes in the economy occur before lagging indicators change. For example, employment as shown by the Employment Situation report tends to continue to fall or grow very slowly as the economy comes out of a recession (even though unemployment rates often rise as the economy enters a recession). Lagging indicators may not tell the future, but they’re great for confirming where the economy has been and whether it’s heading toward recession or expansion.

  • Balance of trade

Also called the Net exports, Balance of trade refers to the difference between a country’s total value of exports and imports. It tells us whether the country is in a trade surplus (higher exports) or trade deficit (higher imports).

A surplus is generally desirable as it indicates more money flowing into the country. If the surplus is due to high exports, it signals a strong demand for the country’s exports from other countries. A high trade deficit is a negative indicator of economic growth, and markets react negatively.

  • Unemployment rate

Another measure of economic performance is the Unemployment rate, which is measures the number of people unemployed as a percentage of the total labour force. Higher unemployment indicates a poor state of the economy companies less willing to hire, reduced aggregate demand and further layoffs. It has been observed that the unemployment rate is negatively correlated to the prices in the stock market.

  • Gross domestic product

The most popular measure for the size of the economy is the Gross Domestic Product (GDP). It is the total value of all goods and services produced within a country in a particular time period. The growth rate of GDP indicates the health of the economy.

The GDP data for India is calculated quarterly and is released by the Central Statistics Office. High growth in GDP indicates growth in income and strong aggregate demand, and corporates are likely to perform better in such an environment.

Concurrent Indicators

Coincident indicators are analyzed and used as they occur. These are key numbers that have a substantial impact on the overall economy.

Personal income is a coincident indicator of economic health. Higher personal income numbers coincide with a stronger economy. Lower personal income numbers mean the economy is struggling. The gross domestic product (GDP) of an economy is also a coincident indicator.

These indicators may not offer much in the way of forecasting ability, but they do tell a lot about current economic conditions. Examples include the Gross Domestic Product (GDP) report and the Personal Income and Outlays report (specifically the personal income statistics).

  • Inflation

This is a measure of the change in prices of goods and services over a period of time. A little positive inflation signifies strong demand that promotes economic growth, whereas very low or negative inflation is a signal of weak demand and usually coincides with low growth in the economy.

In developing countries like India, high inflation can be a cause of worry as it reduces the real disposable income of consumers and businesses may face a reduction in their profit margins due to an increase in the cost of inputs. Various indices are used to measure inflation. An index tracks the changes in the prices of a basket of goods and services.

  • Short term interest rates

Short term interest rates are very sensitive to current economic conditions and are strongly influenced by the policy rate (Repo rate) set by the Reserve Bank of India. A rise in short term interest rates signals higher economic activity as there is more demand for money.

  • Manufacturing activity

Industrial/manufacturing activity is sensitive and quickly adjusts to the current economic scenario. Increased industrial production indicates that there is a strong demand for goods, and since the industrial sector is closely linked to other sectors of the economy, higher industrial activity correlates positively with growth in other sectors.

An index that tracks the growth in manufacturing activity in the economy is the Index of Industrial Production (IIP). The IIP is calculated monthly and released by the Central Statistics Office. Low or negative growth in the IIP is bad for corporate sales and profits; thus, stock prices fall in reaction to it.