. 'What 5 key indicators should I track to stay on top of market movements?'
A. Ever wonder why the stock market goes down on good economic news and up on bad--why, for instance, a report of soaring job growth can send Wall Street into a tailspin, while a lazy rate of job creation can spark a rally? It's not mere perversity; the market's movements depend on myriad economic circumstances, even if the relationship sometimes seems to defy logic.
Several times a day, one or another government agency or trade organization releases a number that offers a glimpse into the state of the economy. Because the economy is cyclical, ebbing and flowing with shifts in supply and demand, indicators can show what phase the economy is in--and where it is headed. Of course, buying or selling stocks and bonds in response to changes in one indicator is a strategy best left to professionals. But investors are wise to note economic trends because share prices are driven by two factors: earnings and interest rates. When the economy is expanding and interest rates are low, earnings--and therefore share prices--likely will rise.
For the broadest view of how the economy is doing, check the Gross Domestic Product, released four times a year during the final week of January, April, July, and October. The GDP measures the nation's total output of goods and services for the quarter. Although quarter-to-quarter changes are too small to be useful, GDP figures over several quarters can reveal whether the economy is on an upward or downward course. That, in turn, helps investors determine whether cyclical industries--such as basic materials and energy stocks--will outperform as the economy nears the end of a recession or underperform when it begins expanding.
Although the GDP tells investors where the economy has been, several other indicators better predict where it is going. These five, favored by economists, are the easiest for investors to interpret.
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Consumer Confidence Index (released the last Tuesday of each month)
Simply put, the better shoppers feel about their financial situations, the more they'll spend. And because more than two-thirds of U.S. corporate earnings are derived from consumer buying, whether people feel flush has a direct impact on corporate profits.
The Conference Board, a nonprofit research organization in New York, compiles the index from the responses of 5,000 households to questions about their current financial situations and their expectations for the economy during the next six months. The results are compared to a base year, 1985, which is set at 100. Lynn Franco, associate director of the Conference Board's consumer research center, says that when the index is above 100, people feel heartened about their economic situation and are likely to continue spending. When it dips below 80 for two consecutive months, a recession is likely to begin within three to six months. However, Franco cautions against reacting to a one-month blip. In January 1998, for instance, the index fell sharply when a congressional impasse over the budget caused the government to shut down, but consumer confidence rebounded over subsequent months.
Employment Situation Report (released the last Friday of each month)
'The mother of all indicators,' is what David Orr, chief economist at First Union, calls this report, which includes a count of the number of jobs created (known as nonfarm payrolls), and changes in wages and hours worked, as well as the unemployment rate.
The bond market typically responds to whether the number of new jobs comes in above or below the consensus estimate, which, Orr says, is often wildly off the mark. But investors should compare the index's three-month average with the average of the prior three months to spot trends. If fewer than 100,000 new jobs are created in each of several months, the economy could be headed for a slowdown; more than 300,000, and it could be overheating. 'Ideally, the Federal Reserve wants to see the number of new jobs in the 150,000 to 200,000 range; then it would never touch interest rates,' says Orr.
The NAPM Index (released the first week of each month)
Closely watched by Federal Reserve Board Chairman Alan Greenspan, this index is compiled by the National Association of Purchasing Management, which asks managers of 300 companies in industries across the economy about changes in new orders, prices, and supplier deliveries. The results are compared to a base of 50, which means that a reading between 55 and 60 shows the economy expanding at a good clip, while a reading below 44 is considered a warning of recession.
The index's supplier delivery component, according to Orr, may have the most impact on interest rates. Managers are asked if suppliers are delivering orders faster or slower than they did during the prior month. Long delivery times indicate that suppliers may be working to capacity, and therefore have the leverage to raise prices. 'Back in 1994, when the Federal Reserve raised rates pretty consistently, a high supplier delivery number was one reason why,' says Orr.
Consumer Price Index (released the fourth week of each month)
The CPI reflects changes in the prices of a fixed 'market basket' of goods and services purchased by the typical urban consumer. Increases in the CPI, which is updated about every 10 years, generally are considered warnings of inflation. Although it has been criticized for not quickly taking into account changes in buying patterns and trends, it remains a widely watched indicator. If, during a three-month period, the CPI rises by an annualized rate of at least 8%, an economic slowdown is likely.
Leading Economic Indicators (released the first week of each month)
The LEI, compiled monthly by the Conference Board, is an index of 10 components, including manufacturing orders, interest rates, and new construction, making it a good all-in-one indicator. Michael Boldin, senior economist at the Conference Board, says changes in the LEI signal turning points in the economy. If the LEI shows a decline of at least 1% during a six-month period, then the economy is headed toward recession. The LEI, Boldin says, has predicted the past six recessions, though delays in compiling the data may make the warning time very short. |
