Some investors are under the mistaken impression that they have no business boning up on financial indicators; that they fall into the domain of pointy-headed economists buried in spreadsheets, charts and graphs.

Not so. An investor who doesn’t understand economic indicators is like a tourist trying to navigate a foreign county without a map. Sooner or later you’ll get lost and it might take you a while to find your way again.

Consequently, it makes sense for investors in the stock market to have a thorough understanding of how the economy works and how economic activity is measured. Here’s a breakdown of the key indicators investors should know about:


-- Business Inventories: A monthly running total of how well companies are selling their products, business inventories are a neon signal to economists and investors alike. The business inventory data are collected from three sources: the manufacturing, merchant wholesalers, and retail reports. Retail inventories are the most volatile component of inventories and can cause major swings. A sudden fall in inventories may show the onset of expansion and a sudden accumulation of inventories may signify falling demand and hence onset of recession.

-- Gross Domestic Product: The gross domestic product (GDP) is the most important economic indicator published. Providing the broadest measure of economic activity, the GDP is considered the nation's report card.

The four major components of the GDP are: consumption, investment, government purchases, and net exports. As the barometer of the nation's total output of goods and services, GDP is the broadest of the nation's economic measures.

-- Consumer Price Index (CPI): The consumer price index (CPI) is considered the most important measure of inflation. It compares prices for a fixed-list of goods and services to a base period. Currently, the base period, which equals 100, is the average prices that existed between 1982-1984.

Unlike other measures of inflation, which only cover domestically-produced goods, the CPI covers imported goods, which are becoming increasingly important to the U.S. economy.

-- Job Growth: Except for the GDP, the government's employment report is the most significant economic indicator reported, setting the tone for the entire month, providing information on employment, the average workweek, hourly earnings, and the unemployment rate.

Economists use payroll jobs data to predict other economic indicators. For example, there is a strong correlation between construction payroll figures and housing starts, manufacturing and industrial production activity, total payroll and personal income. The data is also used to refine GDP estimates.

Consumers feel more at ease when the job market is expanding. But when job growth contracts to 100,000 or less month to month, watch out — the economy could be headed for a slowdown.

-- Consumer Confidence: The Conference Board maintains this index of consumer sentiment based on monthly interviews with 5,000 households. After hitting historical highs last summer, the index has been falling, especially after the terrorist attacks of September 11, 2001.

In bad times or good, consumer confidence serves as a reflection of the nation’s financial health. Sometimes the consumer worries about inflation more than unemployment, and at other times the reverse is true. Consumer confidence is far more important to the financial markets during times of national crisis or panic-such as after the 1987 stock market crash, before and during the 1991 Persian Gulf War, after oil shocks, during recessions and so forth.

As might be expected, consumer confidence is the weakest during recessions, slightly better on average during recoveries, and highest during expansions (like the decade long bull market of the 1990’s.

-- Unemployment Index: The government's employment report covers information on payroll jobs, including employment, average workweek, hourly earnings, and unemployment. Unlike the jobs data, which is a coincident indicator of economic activity (it changes direction at the same time as the economy), the unemployment rate is a lagging indicator. It increases or falls following a change in economy activity. Consequently, it is of far less significance to economists and investors.

In its favor and unlike the payroll jobs data, the unemployment rate is not subject to change. During the past year, the unemployment rate has gradually declined and recently been running at levels below what economists believe to be the "natural rate" or that rate at which sustained unemployment can exist without rekindling inflation. The natural rate has been pegged at 5.5%. Consequently, four months at levels as low as 5.1% have many investors and economists concerned inflation is just around the corner.

-- Housing Starts: This indicator tracks how many new single-family homes or buildings were constructed throughout the month. For the survey each house and each single apartment are counted as one housing start, (a building with 200 apartments would be counted as 200 housing starts). The figures include all private and publicly owned units, with the only exception being mobile homes which are not counted.

Most of the housing start data is collected through applications and permits for building homes. The housing start data is offered in an unadjusted and a seasonally adjusted format. According to the US Census the housing industry represents over 25% of investment dollars and a 5% value of the overall economy. Declining housing starts show a slowing economy, while increases in housing activity can pull an economy out of a downturn.


-- Index of Leading Economic Indicators: The index of leading economic indicators (LEI) is intended to predict future economic activity. Typically, three consecutive monthly LEI changes in the same direction suggest a turning point in the economy. For example, consecutive negative readings would indicate a possible recession.

-- Producer Price Index: The Producer Price Index is a basket of various indices covering a wide range of areas affecting domestic producers. The PPI includes industries such as goods manufacturing, fishing, agriculture, and other commodities. Each month approximately 100,000 prices are collected from 30,000 production and manufacturing firms. There are three primary areas that make up the PPI. These are industry-based, commodity-based, stage-of-processing goods.

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Other good barometers of economic growth include retail sales, employee cost index, factory purchase orders, and new and existing home sales.