U.S. Economic Indicators
Economy is the bedrock of financial markets. The customary way to measure the size and performance of any economy is through Gross Domestic Product (GDP). GDP is one of the great inventions of 20th century. Since 1960, world GDP grew at a compounded rate of 7% a year, rising from $1T to over $70T today. U.S. overtook the U.K. to become the worlds’ largest economy in 1872 and has remained so over 140 years. The U.S. economy is currently at $16T
World GDP: 1960-2016 (Source: Bloomberg)
This essay will illustrate:
How investors use economic indicators to gauge the health of the economy?
What is the most important indicators to the U.S. economy?
How these indicators can be used to spot inflection points of the economy?
Part I
Gross Domestic Product Indicator
GDP Composition by ExpenditureComposition of GDP varies from country to country. U.S. is plainly consumer driven. While in China, investment comprises 50% of GDP, and in Denmark, with its renowned social safety net Government Consumption comprises 26% of GDP
C: Personal Consumption
I: Private Business Investment
G: Government Consumption
X: Export
M: Import
X-M: Net Export (If X-M >0, the country is a net exporter, vice versa)
Part II
Five Essenstial Economic Indicators
Economic GrowthWhy it matters?
The first thing investors want to know when examining an economy is the percentage growth in the economy.
Which Indicator?
GDP US Chained 2009 Dollars YoY SA (Real GDP Growth Rate)
Frequency: Quarterly (a month after the end of the quarter)
Source: Bureau of Economic Analysis (U.S.)
Data Input: Whole Economy
Note
The flat green line represents the dividing line between growth and recession. A recession is defined as two successive quarters of negative real GDP growth. The economy is cyclical and in red are the recessions.
Cyclical U.S GDP Growth: 1948-2014 (Source: Bloomberg)
Why it matters?
Inflation is the general increase in the prices of goods and services which diminishes the purchasing power of money. Inflation is a primary driver of rising salaries which are needed to counteract the rising cost of living which results from inflation. Inflation is popular as a means to unveil the real GDP. Fixed incomes investors watch for any signs of inflation, which erode the value of bonds.
Which Indicator?
GDP Price Deflator
Frequency: Quarterly (a month after the end of the quarter)
Source: Bureau of Economic Analysis (U.S.)
Data Input: Whole Economy
Consumer Price Index (CPI)
Frequency: Monthly (published around middle of the following month)
Source: Bureau of Labor Statistics(U.S.)
Data Input: Basket of Goods and Services
Note
CPI basket varies from country to country. In China, food is 30%, whereas food accounts for only 15% in the U.S. Housing is 15% in China but about 40% in the States.
CPI basket changes over time, as technologies change, tastes change.
Unemployment (Coincident Indicator)Why it matters?
Consumers market make up more than two-thirds of the U.S. economy. This consumer spending is almost purely driven by salaries. The economy tends to shrink when people lose their jobs. Unemployed workers has to tighten their belts. Unemployment changes in line with GDP, therefore it is a coincident indicator.
Which Indicator?
Nonfarm Payrolls:
Frequency: Monthly (published on the first Friday of the following month)
Source: Bureau of Labor Statistics(U.S.)
Data Input: Number of employees on business payrolls
Why it matters?
Though consumers comprise the bulk of the U.S economy, business leaders make much bigger decisions than consumers. They will only make large investments and hire people when they feel confident that there will be demand for their goods and services in the future. Business confidence is a leading indicator.
Which Indicator?
Purchasing Managers Index (PMI)
Frequency: Monthly (published on the first business day of the following month)
Source: Institute for Supply Management (ISM, U.S.)
Data Input: Regular surveys of corporations' purchasing managers
Standard: 50+ signifies optimism and below 50, pessimism.
Why it matters?
House building accounts for only 3% of the U.S economy, but it is still considered as a strong indicator. The first reason is that, before homebuilders build houses, they need to believe that consumers are confident enough to assume 30-year mortgage. Secondly, house purchasing surges when consumers believe that mortgage rates are low and are set to rise. Interest rates rise when the economy booms. So house purchasing can be a sign of a booming economy.
Lastly, after buying a new house, the new owners buy paint, kitchen wares, mower, furniture, TV…. Therefore, the actual contribution of housing is more than 3% of the GDP.
Which Indicator?
Housing Starts
Frequency: Monthly (published around middle of the following month)
Source: U.S. Census Bureau (U.S.)
Data Input: Number of new housing units that have been started
Part III
Monitoring GDP
Example: Q1, 2016Real GDP growth released by Bureau of Economic Analysis is the most definitive and authoritative barometer of the economy. It is calculated through the integration of hundreds of data sources, such as tax returns, census surveys. After a quarter, it takes a month to come out. For investors, the GDP report is of little practical value. Some more frequently and timely indicators can tell the same story as GDP growth because they are correlated with it.
Given the strong correlation of other more timely economy indicators with GDP growth, the disclosure of the actual GDP growth loses its capacity to surprise. The release of GDP statistics is less interesting to investors than other indicators. Only “New News” makes markets move. Therefore, the economic indicators that most quickly heralds “New News” are of the most value to traders and investors. By the time the official GDP statistics are announced they tend to be yesterday’s news. Therefore, indicators that are published first, such as PMI and nonfarm payrolls in the U.S., attract the most attention.
Strong Correlatio of Economy Indicators (Source: Bloomberg)
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