You can use leading economic indicators to understand the direction of the economy. These indicators can help you predict whether the economy is heading towards a recession or not.
Key Leading Indicators
The yield curve, durable goods orders, the stock market, housing starts and building permits, and the Leading Economic Index from the Conference Board, how to use leading indicators.
The Yield Curve
The yield curve is a leading indicator for recessions. It has predicted all seven previous recessions: 1970, 1973, 1980, 1990, 2001, and 2008. The yield curve shows the yield of short-term Treasury bonds compared to long-term Treasury bonds. In a normal yield curve, short-term bond yields will be lower than long-term bonds. Investors require a higher yield to invest their money for a longer duration.
Durable Goods Orders
Reports on durable goods orders tell you when businesses and consumers order large, high-value goods. Consumer durable goods include furniture, cars, and long-lasting appliances like washing machines. Durable goods for businesses include industrial equipment as well as trucks, boats, and airplanes. When there is an increase in durable goods orders, it typically means the economy is on the rise.
The Stock Market
The stock market can be a good predictive indicator. A company’s stock price is affected by its expected earnings. If earnings estimates are accurate, the strength of the stock market should reflect the general trend of the economy. For example, if the stock market is rising, the earnings estimates of most companies should also be rising, which indicates a healthy economy. If the stock market is declining, the earnings estimates of most companies will also be falling, indicating a weak economy.
Housing Starts and Building Permits
Housing starts refer to new residential construction. When more building permits are issued – leading to more construction – or when more housing construction begins, it means that there is high demand for housing. If starts or building permits begin to decline, it indicates lower demand for new housing. When this occurs, it usually means that something is wrong in the resale market. Real estate is a significant part of the economy, as is construction employment. When this sector weakens, everyone feels it.
Leading Economic Index from the Conference Board
The U.S. Conference Board publishes a leading index that serves as a good indicator of what will happen in the economy.
The Leading Economic Index from the Conference Board measures the economy using 10 economic indicators. Not all of these indicators are leading indicators. The unemployment rate, or weekly unemployment claims, is a lagging indicator.
Here are ten economic indicators used by the Leading Economic Index from the Conference Board to determine the direction of the economy:
- Average weekly hours of manufacturing: shows how much demand there is for factory workers. This sector of the economy is very sensitive to fluctuations in the business cycle.
- Average weekly unemployment insurance claims: shows the number of employees filing for unemployment insurance in that week. It reveals how many people have recently lost their jobs.
- New orders for manufacturers, consumer goods and materials
- New orders for manufacturers, excluding defense and capital goods and aircraft orders
- ISM New Orders Index: surveys over 400 purchasing managers in the manufacturing sector. If the new orders report is above 50, it indicates growth in manufacturing and the economy.
- Building permits
- Stock prices
- Leading credit index: measures six financial indicators such as margin account balances, bank credit, and securities repurchases.
- Interest rate spread, 10-year Treasury bonds, excluding federal funds
- Consumer confidence: based on a survey of consumers. It asks about their future expectations. It tells you whether consumers believe that business conditions, jobs, and incomes will improve over the next six months.
How to
Using Leading Indicators
Leading indicators are the first data point in a new business cycle phase. They occur during the old cycle but give a glimpse of what will happen. Here’s how to use these indicators.
- The yield curve: Pay attention to the yield curve, but remember that it can invert months before an actual recession occurs, and it hasn’t always proven to be reliable. For this reason, monitor it but do not take action until other leading indicators confirm the yield curve’s direction.
- Durable goods orders: Durable goods orders reports can vary significantly from month to month. A large part of these includes commercial aircraft, primarily from Boeing, and their orders fluctuate widely. Also, look at the portion labeled “capital goods orders excluding defense and transportation.” It eliminates the irregularities of commercial and defense aircraft orders.
- The stock market: The stock market can fluctuate greatly for various reasons. Pay attention to the reasons for the changes in the stock market – are there significant losses or gains across all economic sectors, or in certain segments of the economy, or is it just a temporary incident?
- Building permits and housing starts: The building permits report is issued monthly. A quick review will tell you how developers feel about the future of housing. Demand for housing can affect the entire economy.
Frequently Asked Questions (FAQs)
What should I do if economic indicators point to a recession? You can prepare for the recession by
Source: https://www.thebalancemoney.com/leading-economic-indicators-definition-list-of-top-5-3305862
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