A Guide to Economic Indicators Chapter 5 Danielle Ko Trent Musso September 5, 2006

“Reliable” Indicators  Economic indicators are considered reliable if: 1. They undergo minimal revision on average 2. They accurately signal turning points in the economic life cycle  Consist of initial unemployment claims, average manufacturing workweek, non- farm payroll employment, hours worked, industrial production

The Reliables: Initial Unemployment Claims  Most reliable indicator  Measured as new claims for unemployment compensation under state programs  Begin rising just over a year before the start of a recession  Give a shorter warning period before an expansion

The Reliables: Average Manufacturing Workweek  Released monthly by Bureau of Labor Statistics  Accurate, clear pattern  Manufacturers increase the workweek as demand rises, decrease the workweek as demand falls

The Reliables: Non-Farm Payroll Employment  An employment statistic based on 250,000 non-farm establishments  Released monthly by Bureau of Labor Statistics  Preliminary reports are pretty accurate over time

The Reliables: Hours Worked  Released monthly by Bureau of Labor Statistics  Extremely accurate  Generally increases at the beginning of recovery and early in revival  Declines as the expansion matures

The Reliables: Industrial Production  A measure of basic manufacturing health  Estimates physical output of mines, factories, and utilities  Moderate revisions over time  Rises after revival phase begins  As the U.S. becomes more of a service economy, may become less relevant

The Reliables: Help Wanted Advertising  Measured by the Conference Board, a nonprofit private research organization  Reflects relative level of the number of openings in existing and new jobs  Uses data from classified sections of newspapers  Rises at the beginning of expansion, falls as soon as expansion matures

Other High Quality Indicators  Housing Starts & Building Permits Reflects the health of the housing market Housing markets among earliest indicators of change in economic life cycles Housing starts slightly less reliable than permits  Starts vary because of weather conditions  Permits can be filed regardless of weather Bottoming of housing market can indicate that start of an economic Revival

Other High Quality Indicators  Composite Index of Leading Economic Indicators Includes 11 major components  Initial unemployment claims, building permits, stock prices, consumer goods, etc. Useful in helping to signal economic changes Useful but considered overrated Takes into account extraordinary factors  Strikes, severe weather, major stock price movements, etc.

The Unreliables  Why? Extensive revisions Fail to reflect changing composition of U.S. economy  Slow to incorporate faster growing, smaller firms that are taking market share from larger firms Federal budget cutbacks  Limit ability to expand samples, process data, and improve accuracy

The Unreliables  Retail Sales “Unreal Tale” Initial report is extensively revised  Durable Goods Orders Include big-ticket Department of Defense contracts that are spread unevenly over the year, this skews the data  Purchasing Managers Survey Ignores managers at fast growing smaller firms

The Unreliables  Unemployment Rate Problems with rate calculations and includes such groups as teenagers  Corporate Profits Reported late, 45 to 75 days after quarter end  Consumer Sentiment Survey Not very practical and has not done well identifying phases in the economic cycle Reflects present conditions rather than future

A Trip Through the Economic Life Cycle  Revival Housing market, building permits, and housing starts to bottom out Initial unemployment claims fall Industrial production figures rise  Acceleration Key indicators of Revival remain positive Business spending takes off Average manufacturing workweek drops

A Trip Through the Economic Life Cycle  Maturation Building permits & housing starts fall Less help wanted advertising Leading economic indicators drop Significant increase in initial unemployment claims

A Trip Through the Economic Life Cycle  Ease-off Major economic indicators show sharp negative trends, especially non-farm payroll unemployment, hours worked, manufacturing workweek, & industrial production  Plunge Negative trends of ease-off continue First sign of recovery is increase in manufacturing workweek

Putting It All Together  Where to look The Wall Street Journal, Business Conditions Digest  Watch your step A matter of constant comparisons Revisions Understand terminology: real vs. nominal, seasonally adjusted  Making your own adjustments

Making Final Investment Decisions  Identify trends in individual indicators, compare to trends in other indicators  Consider what kind of investor you are  Economic indicators important in transition from Ease-off to Plunge!  Economic understanding…and judgment!