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What Every Trader Should Know About Economic Indicators

By Vincent Mao

 

Within each month the release of key economic data
can certainly make an impact on the financial markets. If the data released is
in line with expectations, it could be a non-event. If the release in not in
line with expectations, it can turn things upside-down. In this lesson, I will
introduce you to some of the most important economic indicators. In addition, I
will show you how to interpret the data as well as how you can trade off the
data.

Economic indicators
and reports such as the CPI, PPI, and the unemployment report are gauges or
tools that tell you about the health of the economy. They tell you about the
strength and condition of the economy. They can also hint towards the future of
the economy. There are number of economic indicators/data that are released each
month. The following are what I view to be the most important indicators:

1. CPI (Consumer
   Price Index)
2. PPI (Producer
   Price Index)
3. Gross Domestic
   Product (GDP)
4. Employment Report
5. Housing Starts
6. Industrial
   Production/Capacity Utilization
7. National
   Association of Purchasing Manager’s Index
8. Retail Sales

Consumer Price Index (CPI)

What it is: The Consumer Price Index (CPI) is a
measure of the change in prices paid by consumers for a fixed basket of goods
and services. The CPI compares the price-level changes in a basket of goods and
services from month-to-month or year-to-year. It is one of the most important
economic indicators, since it is one of the most widely followed measures of
inflation.

What it says: The CPI tells you whether goods and
services are becoming cheaper or more expensive. In other words, it tells you
about the purchasing power of your money.

Timing of releases: Monthly, approximately the 15^th
of each month. Data released is for the previous month.

What to look for: Look at changes in the “Core”
CPI, which is the CPI without food and energy. Oftentimes, the Core CPI is
looked at more than the regular CPI. This is due to the high volatility in food
and energy prices. Any signs of inflation.

Impact on stock market: An increase in the CPI
would indicate an increase in inflation. Therefore, it would be bad for the
stock market. A decrease in the CPI would be good for the stock market, since it
would indicate that inflation is under control.

Producer Price Index (PPI)

What it is: The Producer Price Index (PPI) is a
group of indexes that measure changes in the selling prices received by domestic
producers of goods and services. The PPI measures price changes from the
perspective of the producer or seller.

What it says: It tells you about price changes at
the wholesale level.

Timing of releases: Monthly, approximately the 11^th
of every month. Data released is for the previous month.

What to look for: Any signs of rising inflation.
Since the PPI is released several days ahead of the CPI, it can be an early
warning of pricing pressures on the consumer side. Also, much like the CPI,
focus on the Core PPI since it provides a better picture of underlying
inflation.

Impact on stock market: Just like the CPI, an
increase in the PPI would indicate rising inflation and therefore a declining
stock market. A decrease in the PPI would indicate that inflation is on the
decline and therefore a rising stock market.

Gross Domestic Product (GDP)

What it is: Gross Domestic Product is the broadest
measure of the health of the U.S. economy. It measures the total value of all
goods and services produced and consumed in the U.S. The percentage change in
GDP shows us the growth rate of the U.S. economy.

What it says: Tells you whether the economy is
growing or not.

Timing of releases: Monthly, though GDP is actually
a quarterly figure. Each month an initial estimate is released.

What to look for: Sharp rise or decline in
inventories. Determine whether this is due to an increase or decrease in demand.

Impact on stock market: An increase in GDP would
point to a rising stock market, while a decrease in GDP would point to a
declining stock market.

Employment
Report

What it is: Perhaps the most important economic
report monitored by the financial markets. It’s usually the first major economic
release each month. It is comprised of two reports: one produces the
unemployment rate, the other produces the nonfarm payroll report, average
workweek, and average hourly earnings.

What does it say: What percentage of people are
unemployed? Are workers working longer hours? Are workers getting paid more?

Timing of releases: Monthly, data is for the
previous month. Each release is usually at the beginning of each month.

What to look for: Total changes in payroll
employment. Changes in average hourly earnings and total hours worked.
Unemployment rate compared to various historical periods.

Impact on stock market: An increase in payroll
employment would mean a rising stock market, while a decrease in payroll
employment would mean a declining stock market. An increase in the unemployment
rate would mean a declining stock market, while a decrease in the unemployment
rate would mean a rising stock market.

Housing
Starts

What it is: An indicator that tracks the
construction of new single-family homes, townhouses, and buildings. It is a
leading indicator of future economic activity. Housing starts is really an
all-encompassing indicator that ties in with many other economic issues.

What it says: Tells you about the number of new
homes that are being built.

Timing of releases: Monthly, approximately the 16^th
of each much. The data is of prior two months.

What to look for: Besides the number of new homes
that are being built, housing starts can give you insights into
interest/mortgage rates and consumer confidence. An increase in housing starts
also increases demand for furniture and appliances. It is usually the first
indicator to turn down, when the economy goes into recession. It is also the
first to rise when the economy rebounds.

Impact on stock market: An increase in housing
starts would mean a rising stock market. A decrease in housing starts would mean
a declining stock market.

Industrial
Production/Capacity Utilization

What it is: Industrial production (IP) is a
two-part report which includes capacity utilization. Industrial production is a
measure of the physical output of the nation’s factories, mines, and utilities.

What it says: Tells you about the about what is
happening in the manufacturing sector.

Timing of releases: Monthly, released around the 15^th
of each month. Data is for the previous month.

What to look for: Production trends across
different industries. Changes in capacity utilization can suggest changes in
producer prices and consumer prices.

Impact on stock market: An increase in Industrial
Production and Capacity Utilization would mean a rising stock market. A decrease
in Industrial Production and Capacity Utilization would mean a declining stock
market.

Purchasing Managers’
Index (NAPM)

What it is: An index based on surveys of 300
purchasing managers in different industries nationwide.

What it says: Tells you about the strength of the
manufacturing sector.

Timing of releases: Monthly, on the first business
day of the month. Data is for the previous month.

What to look for: Turning points in the index which
could suggest an increase or decrease in economic activity. An index value of 50
and above indicates expansion in the manufacturing sector, while an index value
below 50 suggests a contraction in the manufacturing sector.

Impact on stock market: The stock market is very
sensitive to unexpected changes in the index. An increasing in the NAPM suggests
a rising stock market and a decrease in the NAPM suggest a declining stock
market.

Retail Sales
Report

What it is: A report on the sale of merchandise for
cash or credit.

What it says: Tells you what consumers are up to.
Are consumers buying?

Timing of releases: Monthly, approximately the 11^th
of every month.

What to look for: Patterns in consumer spending.

Impact on stock market: The stock market is highly
sensitive to retail sales. An increase in retail sales suggests a rising stock
market while a decrease in retail sales suggests a declining stock market.

 

Studying economic
indicators can be very beneficial to your trading, as it can help you gain a
deeper understanding of the economy and the business cycle. It can also help you
determine the health and future direction of the economy in relation to the
current economic conditions. For trading purposes, the most important thing to
know about economic indicators is whether or not the numbers meet market
expectations.

Since the majority
of releases are announced during pre-market hours, tension is often thick at the
starting gate. Once the gate is opened, the markets will begin to digest the
news. The release is usually assimilated quickly, but sometimes it can take a
while for the market to digest the news. In addition, prior to certain releases,
market behavior changes in anticipation. The best way to prepare for economic
releases would be to look at their historical changes in relation to the
underlying business cycle. Although this is easier said than done, it can help
you a great deal in your trading and your understanding of the markets.