A Guide to Economic IndicatorsChapter 5

Danielle KoTrent MussoSeptember 5, 2006

“Reliable” Indicators

Economic indicators are considered reliable if:1. They undergo minimal revision on average2. They accurately signal turning points in the

economic life cycle Consist of initial unemployment claims,

average manufacturing workweek, non-farm payroll employment, hours worked, industrial production

The Reliables: Initial Unemployment Claims

Most reliable indicator Measured as new claims for

unemployment compensation under state programs

Begin rising just over a year before the start of a recession

Give a shorter warning period before an expansion

The Reliables: Average Manufacturing Workweek

Released monthly by Bureau of Labor Statistics

Accurate, clear pattern Manufacturers increase the

workweek as demand rises, decrease the workweek as demand falls

The Reliables: Non-Farm Payroll Employment

An employment statistic based on 250,000 non-farm establishments

Released monthly by Bureau of Labor Statistics

Preliminary reports are pretty accurate over time

The Reliables: Hours Worked

Released monthly by Bureau of Labor Statistics

Extremely accurate Generally increases at the

beginning of recovery and early in revival

Declines as the expansion matures

The Reliables: Industrial Production

A measure of basic manufacturing health

Estimates physical output of mines, factories, and utilities

Moderate revisions over time Rises after revival phase begins As the U.S. becomes more of a

service economy, may become less relevant

The Reliables: Help Wanted Advertising

Measured by the Conference Board, a nonprofit private research organization

Reflects relative level of the number of openings in existing and new jobs

Uses data from classified sections of newspapers

Rises at the beginning of expansion, falls as soon as expansion matures

Other High Quality Indicators

Housing Starts & Building Permits Reflects the health of the housing market Housing markets among earliest indicators of

change in economic life cycles Housing starts slightly less reliable than

permits Starts vary because of weather conditions Permits can be filed regardless of weather

Bottoming of housing market can indicate that start of an economic Revival

Other High Quality Indicators

Composite Index of Leading Economic Indicators Includes 11 major components

Initial unemployment claims, building permits, stock prices, consumer goods, etc.

Useful in helping to signal economic changes Useful but considered overrated Takes into account extraordinary factors

Strikes, severe weather, major stock price movements, etc.

The Unreliables

Why? Extensive revisions Fail to reflect changing composition of

U.S. economy Slow to incorporate faster growing,

smaller firms that are taking market share from larger firms

Federal budget cutbacks Limit ability to expand samples, process

data, and improve accuracy

The Unreliables

Retail Sales “Unreal Tale” Initial report is extensively revised

Durable Goods Orders Include big-ticket Department of Defense

contracts that are spread unevenly over the year, this skews the data

Purchasing Managers Survey Ignores managers at fast growing smaller

firms

The Unreliables

Unemployment Rate Problems with rate calculations and includes

such groups as teenagers Corporate Profits

Reported late, 45 to 75 days after quarter end

Consumer Sentiment Survey Not very practical and has not done well

identifying phases in the economic cycle Reflects present conditions rather than future

A Trip Through the Economic Life Cycle

Revival Housing market, building permits, and

housing starts to bottom out Initial unemployment claims fall Industrial production figures rise

Acceleration Key indicators of Revival remain positive Business spending takes off Average manufacturing workweek drops

A Trip Through the Economic Life Cycle

Maturation Building permits & housing starts fall Less help wanted advertising Leading economic indicators drop Significant increase in initial

unemployment claims

A Trip Through the Economic Life Cycle

Ease-off Major economic indicators show sharp

negative trends, especially non-farm payroll unemployment, hours worked, manufacturing workweek, & industrial production

Plunge Negative trends of ease-off continue First sign of recovery is increase in

manufacturing workweek

Putting It All Together

Where to look The Wall Street Journal, Business

Conditions Digest Watch your step

A matter of constant comparisons Revisions Understand terminology: real vs.

nominal, seasonally adjusted Making your own adjustments

Making Final Investment Decisions

Identify trends in individual indicators, compare to trends in other indicators

Consider what kind of investor you are

Economic indicators important in transition from Ease-off to Plunge!

Economic understanding…and judgment!