Investor Interpretation of Economic Indicators
Economic Data Important for Stock Traders Who Understand Its Impact
The financial media has built an entire industry out of providing and interpreting economic information. Yet, much of the banter is irrelevant at best, and misleading at worse. Investors seeking to understand where the economy is in terms of the recession/expansion cycle need only focus on four simple but reliable indicators.
Based on data extending back to 1970, all six of the United States' recessions have been flagged- usually before they began or right at their beginning- by one common, simultaneous arrangement or sequence of only four economic indications.
Rising Unemployment
By far one of the most reliable and most consistent clues of a looming recession, a mere three months worth of rising unemployment rates has coincided with each and every recession since 1970. The absolute unemployment rate has not been a factor- only rising unemployment, whether it is a move from 3% to 4%, or from 9% to 10%.
Note, however, that unemployment has been observed to continue to rise even after a recession has ended and an expansion phase has begun again.
Falling Capacity Utilization
How many of the nations' factories, machines, and assembly lines are actually in use? The long-term average is around 79%. In expansion phases, utilization rates can exceed 85%, and in economic troughs the capacity utilization figure can drop below 75%.
All the technical recessions witnessed since 1970, however, have occurred while capacity utilization was falling. These same recessions ended almost exactly when capacity utilization began to move higher again, though a cause-effect relationship isn't necessarily the reason for the simultaneous recovery of both.
Falling Fed Funds Rate
The Federal Reserve has at least a reasonable idea when an economic cooling is looming, and its first line of defense to combat a recession is to lower interest rates (which stimulates spending). Specifically, the Fed will lower the baseline Federal Funds rate.
Though the maneuver never actually staves off a recession, it coincides with them quite consistently.
Peaking Inflation Rate
Though the inflation rate is by far the most volatile data set of the four, in general, recessions begin when or shortly after inflation has surged and/or peaked.
Investors should be cautious not to assume any short-term surge in inflation or sustained inflation rates are a sign of economic trouble ahead though, as some of the market's strongest bullish phases have occurred when inflation was high and moving higher. In fact, the rising inflation may well have been the cause for the market's strength. It is only one sign.
On that note, investors should be cautions not to assume any one of these four economic clues by themselves are a solid sign of an economic trough, It's the simultaneous combination of all these hints that usually predicts a recession.
Other Economic Indicators
Clearly these four indications are not the only ones an investor may be exposed to by the media. Gross Domestic Product (or GDP), market-wide earnings health, consumer confidence, payroll information, consumer spending, and others represent important information. However, these other data sets are also inconsistent, and can be influenced by non-economic factors (and vice versa).
The four economic indicators described above, however- while not perfect- are mostly shielded from influences that can cause the economy to appear healthier or sicker than it actually is.
Economic Indicators of a Recession
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