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Why economic indicators guide investor behavior

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Sep. 4 2014, Published 8:22 a.m. ET

Economic indicators

Economic indicators are economic statistics—like the unemployment rate, gross domestic product (or GDP), or the inflation rate—that indicate how well the economy is doing. They also indicate how well the economy is expected to do in the future. Investors use all the information at their disposal to make decisions. A set of economic indicators could suggest that the economy is going to do better or worse in the future than what was expected. As a result, investors could decide to change their investing strategy. Economic indicators are differentiated based on timings. They can be leading, lagging, or coincident.


Leading indicators

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Leading economic indicators are indicators that change before the economy changes. An example is the stock market indices. The stock market indices are mainly guided by future expectations. The SPDR S&P 500 ETF (SPY) represents the performance of the large capitalization sector in the U.S. equity market. It usually starts to decline before the U.S. economy declines. It also improves before the economy recovers. Other popular exchange-traded funds (or ETFs)—like the Vanguard Total Stock Market ETF (VTI) and the Dow Jones Industrial Average ETF (DIA)—invest in blue-chip stocks like Johnson & Johnson (JNJ) and ExxonMobil (XOM). These ETFs represent the expected trend in the U.S. economy.

Lagging indicators

Lagging economic indicators are indicators that don’t change direction until a few quarters after the economy changes. The unemployment rate is an example of a lagging economic indicator. An economy’s unemployment rate usually starts to improve about two or three quarters after the economic conditions start to improve.

Coincident indicators

Coincident economic indicators are indicators that move at the same time the economy does. The GDP is an example of a coincident economic indicator. Declining GDP growth rate reflects declining economic activity in the current period. In contrast, an improving GDP growth rate represents an increase in economic activity.

The GDP figures for the second quarter in U.S. came out in the past week. They were a little stronger-than-expected.

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