Theory of economics

Figure 1. Connection between Leading and Lagging indicators¹

Market participants will be keeping an eye on analysts’ predictions of the data ahead of their release. The bigger the difference between the analysts’ predictions and the actual figure, the more volatility can be expected in financial markets – as positions are adjusted to reflect the actual figure1.

The best macroeconomic indicator to watch will heavily depend on your personal preferences, what positions you are taking and which country your portfolio is focused. However, there are some very common indicators that most traders and investors will keep an eye on.

For simplicity’s sake, we have split these out into leading and lagging indicators. Top leading indicators:

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  The stock market
  
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  House price
  
• 
  Bond yield
  
• 
  Production and manufacturing statistics
  
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  Retail sales
  
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  Interest rates
  

Stock market. The stock market is considered a good predictive indicator of economic health, because market participants spend their time assessing the health of companies and the economy, so are well placed to judge future growth.

A rise in the stock market indicates confidence in the future of businesses, which could lead to economic growth. While a decline in the stock market could mean that investors are taking their money out of shares and retreating to safe-haven assets.

There are some inherent issues with relying on the stock market as an economic indicator, mainly that the prices are often based on speculation rather than the true value of a company. This is why stock prices can be over- and under-valued. The stock market has also experienced significant bubbles ahead of market crashes, which can create a false sense of optimism about the state of the economy. This happens when traders and investors ignore other macroeconomic indicators and get swept along in the bullish market sentiment.

House prices and the real estate market. The housing market is widely considered a leading indicator, because the information can inform the state of the economy months in advance.

A decline in housing prices suggests that the number of houses exceeds the amount of people looking to buy. This could be because prices are inflated, or people simply cannot afford to buy. When the housing sector weakens, the entire economy feels it. The decline can have an impact on homeowner wealth, jobs in the construction sector and taxes, and can also force homeowners into foreclosure – the name given to the process of lenders seeking to recover the mortgage loans from borrowers.

The 2008 recession is a prime example of the impact the housing market has on the economy as a whole. The subprime mortgage crisis didn’t remain sealed inside the real estate market, and was instead an early symptom of what would become the global financial crisis.

The number of building permits can be a leading indicator of economic health, because companies will apply for these permits at least six months before they start construction. If new projects start, this is seen as an indication that these companies expect demand for homes to rise. If house construction starts to fall, then builders are more pessimistic about the future of the market.