PERSONAL FINANCE : BACK TO BASICS : GOOD INDICATIONS : Indexes Can Help You Read the Economy
Inflation is up. The dollar is down. Employment is growing. The trade deficit is shrinking. The Federal Reserve is tightening. Consumers aren’t spending. A recession is around the corner. But not this year.
Huh? Every day, it seems, we’re bombarded with economic statistics on everything from how vigorously U.S. factories are running to how much money foreigners are spending on American products.
If you don’t know how to interpret them, they add up to a confusing, contradictory jumble. But if you do, you can anticipate the direction of inflation, interest rates and other economic forces--a valuable tool in making wise investment and spending decisions.
There’s no reason why--with a little homework--you can’t take a shot at being your own economic forecaster. Remember: Economists get paid good money to do it, and they’re wrong a lot of the time.
But bear in mind that each economic indicator is only one small piece in a giant puzzle. According to the experts, the key to reading the economy is to look for broad trends over time and not put too much faith in any one statistic. The government frequently revises its numbers, anyhow.
“You’re dealing with raw material,” cautions Norman Robertson, chief economist at Mellon Bank in Pittsburgh. “It’s not that complete, and it’s not that accurate.”
Robertson and others also point out that indicators rise and fall in significance, depending on the economic climate of the time. These days, those who try to fathom the economy are most interested in whether inflation is emerging--a development that would threaten higher interest rates, and, ultimately, a recession. They are looking with interest at America’s suddenly booming factory sector. And they are avidly watching the level of consumer spending, a crucial economic engine that has shown signs of tiring out lately.
What then are the signs you should watch for in order to be your own economic seer? Let’s look at several:
Unemployment: The unemployment rate, reported by the Labor Department and currently at about 5.5%, gives important insight into the economy’s strength for several reasons. Most obviously, it suggests whether industry is creating more or fewer jobs. The implications are powerful: If more Americans are employed, they will have more cash to spend and more confidence in spending it. Analysts also like this figure because it comes out early--on the first Friday of the month--providing a timely snapshot of economic activity the month before.
The report also includes data on the number of new jobs created outside farms. These figures are less quoted than the unemployment rate, but provide a more detailed glimpse of how America’s job machine is performing. David M. Jones, chief economist of the Aubrey G. Lanston & Co. securities firm in New York, calls the unemployment report “the single most important batch of statistics for the preceding month.”
Inflation: The consumer price index, also reported by the Labor Department, weighs price increases for food, energy and other major categories and is running at an annual rate of between 4% and 5%. But the figure is easily skewed by gyrations in energy and food prices, so the CPI for any one month should be interpreted with caution.
Analysts also look at the producer price index, which measures wholesale prices and is released by the department several days before the CPI. The PPI has breakdowns, for example, of inflation for goods that are just going into the production stream, thus offering a glimpse into the future. Unlike the CPI, however, it does not include prices for service expenditures, so its use is limited.
For more clues to the direction of prices, look up the sensitive materials price index, published in the Journal of Commerce newspaper. It tracks prices of 18 raw materials used by industry. But don’t try to be too clever. In a world of tough international competition, it is not entirely clear how much these raw material price hikes are passed on to consumers.
Merchandise trade: This is the monthly report by the Commerce Department on the nation’s trade balance. The financial markets often interpret a shrinking deficit as a positive sign of U.S. economic competitiveness, and the dollar may strengthen as a result. A growing deficit has the opposite effect. In particular, it disturbs financial markets because a weakening dollar causes upward pressure on interest rates.
But the number is notorious for bouncing around from month to month, sometimes obscuring long-term trends. Most analysts believe that the trade deficit is now shrinking, even though disappointing future reports are possible. In fact, many investors who previously bemoaned the trade gap are worried now that U.S. exports are growing too swiftly, a harbinger of inflation.
Gross national product: This is the broadest measure of all U.S. economic activity and is the statistic economists typically use when they refer to “economic growth.” Strong GNP growth therefore means the economy is robust. It is reported by the Commerce Department one month after the end of the quarter being reviewed and then revised twice in the following months. GNP ran at a strong 3.9% annual growth rate during the first three months of this year.
Index of leading economic indicators: Despite its name, this monthly Commerce Deparment report on where the economy is headed doesn’t get a lot of respect these days. The index, composed of 11 disparate categories, including new unemployment claims, building permits and stock prices, is hardly a certain predictor of the economic future.
The index is noted for foretelling downturns--three monthly drops in a row are supposed to point to a recession. But due perhaps to the complexity of the U.S. economy and changing global conditions, many economists no longer place much faith in it.
“It isn’t the be-all and end-all of what’s going to happen,” says Michael Penzer, an economist with Bank of America in San Francisco.
Consumer spending: It represents two-thirds of the economy, so its importance can’t be exaggerated. Track it through a few indicators. The first hint comes early in the month, when major retailers, such as Sears, Roebuck & Co. and K mart, report on their own sales performance for the previous month. This is followed several days later by the Commerce Department’s U.S. retail sales statistics. But the most important yardstick comes from the department later in the month and is known as personal consumption expenditures.
Unlike the retail reports, this one shows what consumers spent on services, durable goods (major items such as furniture that will last three years or more) and non-durables (items with shorter lives, such as food and clothing).
Since 1987, growth in consumer spending has generally been slowing, while the slack has been picked up by manufacturing, bolstered by export growth as the dollar has fallen and made U.S. goods cheaper overseas. This shift is fundamental to many analysts’ view of today’s economy.
To follow manufacturing, you should monitor several government indicators. Together, these indicators offer insight into the optimism of business executives and the likelihood that they will invest in their own industries. They include:
Factory orders: The Commerce Department reports data on orders factories got during a month, several weeks later. Analysts make sure they read the report on orders for durable goods, which also includes the important category of non-defense capital goods--equipment and machinery used by industry.
Several days later, the government follows up with a more comprehensive report that includes orders for all kinds of factory goods. The broader gauge “is really important as a leading indicator. Those new orders foreshadow future production,” says Jones of Aubrey G. Lanston & Co.
Industrial production: The industrial production figures by the Federal Reserve Board document the level of activity in the nation’s mines, factories and utilities. To provide more insight, they further divide manufacturing activity into consumer goods, durables and non-durables.
Capacity utilization: Once a little-watched indicator, the Fed’s report on factory operating rates--what percentage of full capacity factories are running at--is suddenly viewed with keen interest by experts. Why? U.S. factory operating rates have been hovering in the 82% to 83% range, the highest in several years.
This statistic provides insight into inflationary pressures affecting the economy. Excessively high operating rates--some economists estimate in the mid-80s or higher--may cause shortages and force up prices.
LEADING OR MISLEADING? Over the years, the Commerce Department’s index of leading economic indicators has been noted for foretelling downturns--three monthly drops in a row in the index are supposed to point to a recession. But due perhaps to the economy’s growing complexity and charging global conditions, many economists no longer place much faith in it.
As the chart below shows, skeptics may be right. A case can be made that the index has lost its crystal ball powers in the past two years or so, as shown by the diverging paths of the leading indicators and gross national product.
INVESTMENT SCORECARD How do you know whether your investments are performing up to par? The following shows compounded annual rates of return in percent for various financial and tangible assets for periods ended June 1.
20 10 5 1 years years years year Coins 15.1 13.4 10.1 14.0 U.S. stamps 12.9 10.5 0.2 1.4 Gold 12.8 9.6 2.2 3.1 Chinese ceramics 12.0 9.2 5.5 10.5 Oil 9.9 3.7 -10.7 19.5* Diamonds 9.9 9.6 7.5 24.9 Old masters 8.8 8.0 12.0 13.4 Treasury bills 8.5 10.1 7.6 6.0 Bonds 8.1 10.3 13.4 6.2 Housing 7.7 6.2 5.0 2.0 Stocks 6.8 13.3 13.6 -4.9 Consumer price index 6.3 6.1 3.3 3.1 Silver 5.9 2.8 -11.6 -7.4 U.S. farmland 5.9 0.6 -6.5 3.1 Foreign exchange 4.7 3.2 9.5 8.6
* Estimated
Source: Salomon Bros.
