economic fundamentals

8/11/2019 Economic Fundamentals

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14 AAII Journal /August 2003

FUNDAMENTALS

THE TOP 10 ECONOMIC INDICATORS:WHAT TO WATCH AND WHY

This article was prepared by the Association for Investment Management and Research (AIMR), a non-profit professional association of 60,000 financial analysts, portfolio managers and other investment professionals in 112 countries. The AIMR is based in Charlottesville, Va.; www.aimr.org.

Economic reports and indicators are those often-voluminous statistics putout by government agencies, non-profit organizations and even privatecompanies. They provide measurements for evaluating the health of oureconomy, the latest business cycles and how consumers are spending andgenerally faring. Various economic indicators are released daily, weekly,mont hly and /or q uart erly.

While it is important to keep a pulse on the economy, few analysts oreconomists wade through all of these massive volumes of data.

Which reports are wo rth itand w hy?H eres a primer on 10 of t he most common a nd vital economic indicato rs.

Even if you dont follow these reports yourself, it is helpful to know wherethe experts are draw ing their opinions from. If yo u do peruse these reports,

remember that data can change rapidly, and that broad trends are not judgedby one isolated economic data point. The box on page 16 provides Web siteaddresses for the top 10 data sources.

1) Real GDP (Gross Domestic Product)

What i s i t? The real G D P is the market value of a ll goods and services produced in a

nat ion during a specific time period. R eal G D P measures a societys wealthby indicating how fast profits may grow and the expected return on capital.It is labeled real because each years data is adjusted to account forchanges in year-to-year prices. The real G D P is a comprehensive w ay to

gauge the health and well-being of an economy.

Why i s i t i mportant? The Federal R eserve uses dat a such as the real G D P a nd o ther relat ed

economic indicators to adjust its monetary policy.

W here does the dat a come from ? The U.S. Department of Commerces Bureau of Economic Analysis releases

the data quarterly, including any revisions, within the last week to 10 days ofeach month following the end of the quarter. Data are spelled out as being advance estimates, preliminary estimates, and final numbers. Eachdat a release includes an explana tion o f w hy t he G D P increased or decreasedfrom t he previous quarter (quarterly data are also a nnualized).

2) M2 (Money Supply)

What i s i t? M2 money supply represents the aggregate total of all money a country has

in circulation. It takes into account all physical currency such as bills andcoins; demand deposit savings and checking accounts; travelers checks; assets

Eco nom ists, analysts,and even ind ivid ualinvesto rs w an t to keepa p ulse on theecono m y. B ut no onew ants to w ad e throug hthe m assive vo lum e o feco nom ic statistics thatare p ut out b y variousentities, b o th

g o vernm en tal andp rivate. A nund erstand ing o f thetop 10 econo m icind icato rs can help younarrow your focus.


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FUNDA M ENTALS

in retail money ma rket a ccounts a ndsmall money market mutual funds,(i.e., less tha n $100,000); individualtime deposits and savings deposits,such as certificates of deposits; inaddition to some repurchase agree-ments and Eurodollar holdings.

It does not include institutional

money fund assets, large denomi-nat ed (more than $100,000) timedeposits, or any special reservesbanks are required to maintain.

Why i s i t i mportant? The Federal Reserve uses this data

to assess current economic andfinancial conditions, a nd to helpalter its monetary policy, w hichincludes raising and loweringinterest rates. The Feds actions are

aimed at bolstering or reducing themoney supply.Economists and others also use

M2 data to predict cyclical eco-nomic recessions and recoveries andexpected changes in stock pricesnot to mention expected changes inthe Feds monetary policy.

Some economists believe that M2srelevancy has waned over the past20 years. For many years thismonetary measurement had closely

paralleled the growt h or contra ctionof the U.S. economy and overallchanges in prices. But over the pasttwo decades, a bevy of changessuch as the introduction of new depository products, the movementof consumer funds from ba nkdeposits to investment accounts andthe internationalization of theeconomyhas caused the moneysupply data to fall out of sync withother economic indicators.

Nevertheless, the Fed and someeconomists and a nalysts pay a tten-tion to the longer-term trends ingrow th or reduction of the moneysupply, particularly the six-monthfigures. And t he Fed reta ins itspower to increase the money supplyby lowering interest rates as a wayto counter a sluggish economy, a ndto reduce the money supply byraising interest rates if the economygets overheat ed.

W here does th e dat a come fr om? The Board of G overnors of the

Federal Reserve System releases thedat a both w eekly (on Thursdays)and monthly, during either thesecond or third w eek of t he month.Mo nthly data goes back to January1959; weekly information has been

available since January 1975.

3) Consumer Price Index (CPI)

What i s i t? The CPI measures changes in the

prices paid for goods and services byurban consumers for the specifiedmonth. The CPI is essentially ameasure of individuals cost of livingchanges and provides a gauge of theinflation ra te related t o purchasing

those goods and services.The CPI does not include everyitem an individual may buy, butinstead takes a sampling of severalhundred goods and services across200 item categories. Data is col-lected through phone calls andpersonal visits in 87 urban areasacross the country.

The CPI does not include income,Social Security taxes, or investmentsin stocks, bonds or life insurance.

But it does include all sales taxesassociated with the purchases ofthose goods and services.

Why i s i t i mportant? This statistic is the best indicator

of inflation that we have to rely on.It is particularly closely scrutinizedby financial economists now since itshows inflation to be at a 16-yearlow. Changes in inflation can spurthe Fed to take action to change itsmonetary policy.

W here does th e dat a come fr om? The U.S. Department of Labo rs

Bureau of Labor Statistics releasesthe national CPIan average of allareas sampled, mo nthly, during thesecond or third week after the end ofthe measured mont h. C PIs for threespecific metropolitan areas are alsopublished mo nthly, w hile C PIs forother specific metropolitan regionsare published every other month.

Data releases include details aboutvery specific pro ducts.

4) Producer Price Index (PPI)

What i s i t? The PPI is a group of indexes that

measures the changes in the selling

price of goods and services receivedby U.S. producers over a period oftime. Think of it as the business-sideequivalent to the CPI that measureschanges in prices paid by consum-ers: The PPI captures price move-ments at the wholesale level, beforeprice changes have bubbled up tothe retail level.

The PPI tracks price changes invirtually all goods-producing sectors,including agriculture, forestry,

fisheries, mining and manufacturing.The PPI also tracks price changesfor a growing portion of the non-goo ds-producing secto rs of theeconomy a s new PPIs are intro-duced. Prices from 25,000 esta blish-ments are tracked monthly.

This report measures prices forgoods a t three sta ges of production:finished goods, intermediate goodsand crude goods.

This was called the Wholesale

Price Index from 1902 until 1978.

Why i s i t i mportant? This index is timely because it is

the first inflation measure availablein the month. In addition, byw at ching crude prices, w hich arefirst in t he chain of prod uctiontrends, one can sometimes spotinflation in the pipeline, before itshows up in the CPI.

W here does th e dat a come from ? The U.S. Department of Labors

Bureau of Labor Statistics releasesthe dat a monthly, during the secondfull week of the month fo llowing thereporting mont h.

5) Consumer Confidence Survey

What i s i t? A gauge of the publics confidence

about the health of the U.S. economythat reflects the publics optimism/


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FUNDAMENTALS

pessimism and the na tions mood.Five questions are asked of a

random sampling of 5,000 individu-als, of w hom a bout 3,500 respond.The survey asks their thoughts andfeelings abo ut business conditions,the labor market, consumer spend-ing and economic growth, and their

financial and employment expecta-tions six months into the future.Each question can be assigned threeopinions: positive, negative andneutral.

Why i s i t i mportant? This statistic is a leading indicator

of consumer spendingconsumersare more inclined to spend moneywhen they are feeling confidentabout their financial and employ-

ment prospects.

W here does the dat a come from ? The Co nference Board s C onsumer

Research Center releases the datamonthly on the last Tuesday of eachmonth.

6) Current Employment Statistics(CES)

What i s i t?

CES provides comprehensive dataon national employment, unemploy-ment and wages and earnings dataacross all non-agriculture industries,including all civilian governmentworkers. Info rmation is disseminat edin many different waysfor example,employment/unemployment rat esamong men and women, variedethnic groups and teens.

Employment data is based on asurvey of 300,000 establishmentsacross 600 industries, w hich accountfor approximately one-third of allpayroll employees. Industries includeretail trade, manufacturing andconstruction. C ES provides details onnumbers of hours worked and earn-ings of all surveyed across the nation.

The employed are defined as allfull- and part-time workers andtemporary a nd intermittent employ-ees who received pay for the citedperiod. It includes those on paidvacation or sick leave, and excludes

business proprieto rs, self-employ ed,unpaid family members and volun-teers.

Why i s i t i mportant? This is the earliest indicator of

economic trends released eachmonth. Employment rat es indicate

the well-being of the economy andlabor force. Changes in wages pointto earnings trends and related lab orcosts. Economists focus on themonthly change in total non-farmpayrolls and in which sectors jobswere gained or lost.

Interesting trends can also bederived fro m the pa yroll dat a, suchas the average number of hours perweek worked and the average hourlyearnings. This data gives an indica-

tion of how tight the labor marketistight labor ma rkets can tra nslat einto wage inflation.

W here does th e dat a come fr om? The U.S. Department of Labo rs

Bureau of Labor Statistics releasesthe data monthly, usually on thefirst Friday following the referencemonth, but always within the first10 days aft er month-end.

7) Retail Trade Sales and FoodServices Sales

What i s i t? This data tracks monthly U.S.

retail and food service sales, detailschanges from previous periods, andidentifies in w hich sectors salesincreased a nd/or decreased.

The data is based on a randomsampling of 5,000 retail and fo odservice firms. Figures are broken outto both include and exclude sales ofautomobiles. Sales are weighted andbenchmarked to represent t henations three million retail and foodservices firms.

Why i s i t i mportant? The numbers measure consumers

personal consumption across retailindustries and tra ck grow th ordecelerat ion of personal consumptionspending, which makes up approxi-mately tw o-thirds of the annua l U.S.

GDP. Analysts use the data to helptrack consumer spending trends andforecast t he direction and magnitudeof future spending. Automob ile salesare separated from the data becauseof their volatility, which can some-times obscure the underlying patternof spending.

W here does i t come from ? The U.S. Department of

Commerces U.S. Census Bureaureleases the data monthly, duringthe second week of each month.

8) Housing Starts (Formally Know nas New Residential Construction)

What i s i t? An approximation o f the number

of ho using units on w hich someconstruction w as performed duringthe month. Data is provided forsingle-family homes and multipleunit buildings. The data indicateshow many homes were issuedbuilding permits, how many housingconstruction pro jects were initiat edand how many home constructionprojects w ere completed.

Why i s i t i mportant?

Housing starts are highly sensitiveto changes in mortgage rates, whichare affected by changes in interestrates. Although this indicator ishighly volatile, it represents about4% of annual G DP, and can signalchanges in the economy a nd t heeffects of current financial condi-tions. Analysts and economists know to watch for longer-term trends inhousing starts.

W here does th e dat a come from ? The U.S. Department of

Commerces U.S. Census Bureaureleases the data monthly, w ithintw o to three w eeks after the end ofthe reporting month.

9) Manufacturing and TradeInventories and Sales

What i s i t? This data represents the combined

value of trade sales and shipments


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AAII Journal /August 2003 17

FUNDA M ENTALS

by manufacturers in a specificmonth, as w ell as t he combinedvalues of inventories in the whole-sale and retail business sectors andmanufacturing. The current and

most recent past months inventory/sales ratios are also provided.Information is provided across17,000 manufa cturing, retail a ndwholesale companies within 160industries.

Why i s i t i mportant? This data set is the primary source

of information on the state ofbusiness inventories and businesssales. Inventory rates often provideclues about the growt h or contra c-tion of the economy. A growth inbusiness inventories may mean salesare slow and the economys rate ofgrowth is also slowing. If sales areslowing, businesses may be forced tocut production of goods, and thatcan eventually translate into inven-tory reductions.

W here does the dat a come from ? The U.S. Department of

Commerces U.S. Census Bureaureleases the data monthly, a pproxi-mately six weeks after the end of thesubject mont h.

10) S&P 500 Stock Index (the S&P500)

What i s i t? The Standard & Poors 500 is a

market-value-w eighted index of 500publicly ow ned stocks that arecombined into one equity basket.This basket of stocks has become theindustry standa rd and b enchmark forthe overall performance of the U.S.equity markets.

The S&P Index C ommitt ee choosesthe indexed stocks based uponmarket size, liquidity and industrygroup representat ion. Co mponentcompanies are periodically replaced.Companies are most often removedbecause of a merger w ith ano thercompany, financial operating failureor restructuring. Pro spective compa -nies are placed in an index replace-ment pool and vacancies are filledfrom that pool.

Why i s i t i mportant? The index is designed to measure

changes in the stock prices ofcomponent companies. It is used asa measure of the nations stock of

capital, as well as a gauge of futurebusiness and consumer confidencelevels. Grow th of t he S&P 500 indexcan tra nslat e into grow th of businessinvestment. It can also be a clue tohigher future consumer spending. Adeclining S&P 500 index can signala tightening of belts for bo th busi-nesses and consumers.

Economists tend to loo k for long-term trends rather tha n short-termfluctuations in the S&P 500 index.The S&P 500s 10-year t ota l return,for example, has become a commonindicator of longer-term trends.

W here does th e dat a come from ? Standard & Poors is solely

responsible for compilation of theS&P 500 index. However, real-timeinformation on the index is avail-able daily from financial newsorganizations and publications, aswell as from Standard & Poors.

1) Real GDP (Gross Domestic Product)U.S. Department of Commerces Bureau of Economic Analysiswww.bea.gov

2) M2 (Money Supply)Board of Governors of the Federal Reserve Systemwww.federalreserve.gov/releases/h6

3) Consumer Price Index (CPI)U.S. Department of Labor, Bureau of Labor Statisticswww.bls.gov/cpi/home.htm

4) Producer Price Index (PPI)U.S. Department of Labor, Bureau of Labor Statisticswww.bls.gov/ppi/home.htm

5) Consumer Confidence Survey The Conference Board, Consumer Research Centerwww.consumerresearchcenter.org

WEB ADDRESSES FOR DATA SOURCES

6) Current Employment Statistics (CES)U.S. Department of Labor, Bureau of Labor S tatisticswww.bls.gov/ces/home.htm

7) Retail Trade Sales and Food Services SalesU.S. Department of Commerce, U.S. Census Bureauwww.census.gov/cgi-bin/briefroom/BriefRm

8) Housing Starts (Formally Known as New Residen- tial C on st ruc tion )U.S. Department of Commerce, U.S. Census Bureauwww.census.gov/cgi-bin/briefroom/BriefRm

9) Manufacturing and Trade Inventories and S alesU.S. Department of Commerce, U.S. Census Bureauwww.census.gov/cgi-bin/briefroom/BriefRm

10) S&P 500 Stock Index (the S&P 500)Standard & Poors Corp.www.spglobal.com

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