What is an economic indicator?

Economic Indicators

Disclaimer TD Direct Investing does not provide advice. This seminar is intended for educational purposes only and as such is not a solicitation or recommendation to make an investment based on the contents of this presentation. Investors should be aware that investments can fall as well as rise and you may not get back all the funds that you have invested and if there is any doubt over the suitability of a particular investment then you should seek independent advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

Contents 

What is an Economic Indicator?

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Defining Economic Indicators

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Revisions

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GDP

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Employment

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Inflation

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CDS Rates

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Housing data

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Novelty Indicators

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How to use indicators

What is an economic indicator? “An Economic Indicator is a piece of economic data, usually of macroeconomic scale, that is used by investors to interpret current or future investment possibilities and judge the overall health of any economy” Source: www.investopedia.com

What is an economic indicator? Economic indicators can be split into three categories: Leading Lagging Coincident

Due to the nature of economic reporting the vast majority of indicators will be lagging to some extent.

Defining Economic Indicators Leading Indicators are popular because they give the earliest warnings about an economy due to change from boom to bust (or vice versa). However, leading indicators can be less reliable than other indicators. For example, the US organisation known as The Conference Board runs an index which has correctly predicted every recession since it started, but has also produced some false signals. This led economist Paul Samuelson to joke “Economists have correctly predicted nine of the last five recessions”.

Defining Economic Indicators Examples of Leading Indicators:  Money

Supply Figures

 CBI

quarterly survey of business confidence (Industrial Trends Survey)

 Monthly  Stock

mortgage approvals figure

market movements

Defining Economic Indicators Lagging indicators use information from the recent past to make predictions. As a general rule, the longer the lag, the more accurate the indicator will be (as it is based on a larger quantity of information). However, an indicator that lags too much could be useless for quick-moving cycles, and using lagging indicators exclusively means it is unlikely an investor will “catch the bottom of the market”.

Defining Economic Indicators Examples of lagging indicators: 

Unemployment rates (Office of National Statistics quarterly figures, US non-farm payrolls)

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Bank of England Inflation report and Monetary Policy Committee meeting minutes

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RPI and CPI inflation rates (ONS monthly figures)

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Council of Mortgage Lenders’ Mortgage Lending figure

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CML House price approvals

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Rightmove/Halifax House prices

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Public Sector Net Cash Requirement (PSNCR) and Average Earnings

Defining Economic Indicators Coincident indicators are those giving information about the current state of the economy. Because of delays in aggregating and formatting data it is often very difficult to get useful coincident data. An example of coincident data might be daily sales figures for a department store, or an announcement of a wave of hirings or redundancies.

Revisions of Economic Data It is not uncommon for economic data to be revised after its initial release. Any revisions are usually outlined in the next regular release e.g. monthly house prices may be revised 1 month later.

GDP Figures GDP is the value of the output of goods and services produced within a country (irrespective of whether or not the business is foreign owned). When the media speak of the term “economic growth” for a country (usually in per cent) they are usually referring to GDP growth. In the UK GDP data is released on a quarterly basis, seven weeks after the end of the quarter i.e. Q1’s data was published towards the end of May. However, as shown on the next slide the UK’s share of global GDP is very small compared to other countries, so figures from other countries can be as important or even more important.

National GDP as share of world GDP (Source: CIA World Factbook 2010-11) USA China Japan Germany France Brazil UK Italy Russia India Canada Spain Australia Rest of World combined

Employment figures American non-farm payroll figures are issued by the Bureau of Labor Statistics at 1.30pm (UK time) on the first Friday of each month. This figure shows the number of jobs created or lost overall in the economy excluding the following: General government employees Private household employees Employees of nonprofit organisations that provide assistance to individuals Farm employees (farms hire and fire seasonally which would distort the figures)

Employment figures The American non-farm payroll figures are often seen as the single most important economic indicator. This is because the US remains by far the largest economy in the world, and so a rise in unemployment indicates a worsening economic situation for the entire world.

In addition to employment figures the full report (available at www.bls.gov) contains data on which sectors are hiring and firing as well as changes in average hourly earnings.

Inflation figures The Bank of England defines inflation as “a general rise in prices across the economy”. The Bank generally quotes two inflation measures: Retail Price Index (or RPI, which monitors prices of rents and mortgage payments) and Consumer Price Index (or CPI, which ignores these).

In an inflationary environment some assets will perform exceptionally well while others will stagnate. As the real value of an investor’s profits may well be hit by a declining currency, it becomes very important to select the right investments.

Inflation measurements Different countries use different measures for inflation and some countries have a higher tolerance for inflation than others. As of October 2011 the highest inflation rate in the world belongs to Uganda which has a rate of 30.5 per cent*. Inflation seems at first glance to have no net effect on an economy and economists have observed an inverse relationship (the Phillips curve) between inflation rates and unemployment suggesting high inflation is desirable. However, because of the uneven distribution of inflation’s positive and negative effects most governments will act to reduce excessive inflation by raising the central bank interest rate (reducing the growth in the money supply).

House prices and mortgage lending Although property and equities are to some extent competing investment classes, both are more likely to perform well in an environment of increasing credit availability. Furthermore, rising house prices have been shown by the National Bureau of Economic Research to create a “wealth effect” where people’s un-crystallised gains encourage them to consume more. The level of mortgage lending appears to be closely linked to house prices, as without new mortgage lending the demand for property tends to fall. Information on prices and mortgage lending is released by Rightmove, Halifax, the Council of Mortgage Lenders and the Royal Institute of Chartered Surveyors.

Novelty Indicators These are mainly issued for humorous purposes but might be useful for timing market moves. Examples include:  Hemline

index (theory that women’s skirts are longer in a recession)

 Big

Mac Index (a measure of purchasing power parity in different countries in a more simple form than a list of exchange rates)

 Cocktail

Party Index (assessing position in the economic cycle based on reaction a banker receives at a cocktail party or other social event)

How to use economic indicators Before a given indicator comes out it can also be useful to have details of the expected result. This is because you will then know how good or bad the figure is compared to the expectation which should theoretically be built into current prices. If more than one prediction is made it is sometimes possible to get a consensus forecast. Different indicators are important to different types of investment (e.g. inflation expectations are extremely important to bond holders, whereas the unemployment rate is more important to retail shares). You can get an idea of what indicators are important by reading documents like analyst reports and company statements.

Questions? If you have any questions please feel free to attend any of our other seminars or book a free personal appointment with one of our Investor Centre Representatives TD Direct Investing Investor Centre 71 High Holborn

London WC1V 6TD Tel: 0845 601 6205

Disclaimer TD Direct Investing does not provide advice. This seminar is intended for educational purposes only and as such is not a solicitation or recommendation to make an investment based on the contents of this presentation. Investors should be aware that investments can fall as well as rise and you may not get back all the funds that you have invested and if there is any doubt over the suitability of a particular investment then you should seek independent advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.