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The three types of economic indicators
Jeff Rose, a certified financial planner, explains the three economic indicators that can point to future changes in the economy.
TAMPA, Fla. - Chances are if you watch the news lately, you wouldn't expect that the stock market continues to hit record highs. Unemployment is still twice as high as it was pre-pandemic. Riots continue to escalate, as we all witnessed with the recent mob that attacked the U.S. Capitol.
Despite all of this, your 401(k) most likely continues to increase. If you are thoroughly confused, don't be. What we are witnessing is very unique, but it also takes into account basic economic indicators.
Economics 101
While there are several economic indicators to consider, the three main types that we'll discuss today are leading, lagging, and coincident indicators. Let's take a look at some examples of each one, so we get a better sense of how our economy affects the stock market.
Leading indicators are those that point to the future changes in the economy, answering the question: Where are we headed? The stock market, or stock prices, are a prime example of a leading indicator. What a stock is currently trading at or selling for, is partially based on what companies are expected to earn.
It's one of the main reasons why Tesla continues to astound investors and spectators alike, with its soaring stock price. Their volume on the number of electric cars they are selling and total revenue doesn't really justify what the stock price is currently priced at, but with their cutting edge technology and being led by visionary Elon Musk, the stock continues to increase.
Lagging indicators are those that come after the economy changes. These are indicators that typically can't be predicted. Unemployment is one of the most common lagging indicators that is used. For example, unemployment for the month of December was 6.7% that wasn't released by the Department of Labor until eight days into the new year.
Coincident indicators are where we are right now. These typically tend to happen at the same time as the economy changes. While there are several examples of coincidence indicators, consumer spending is one that many people can relate to. How much are people currently spending in today's economy is a clear indicator of the financial health and sentiment of consumers.
Now that we have a better understanding of how economic indicators work, how does this apply to the economy? Better yet, how is this affecting the stock market?
How the economy affects the stock market
Based on headlines alone, there is no reason why the stock market should be where it is today. One of the major factors contributing to this is the stimulus packages that the government has passed on to Americans.
We saw the CARES Act last year, and the new package that was recently adopted. Both of these have pumped in trillions of dollars into the economy, helping consumers, small businesses, and corporations alike.
Another factor is quantitative easing, where the government continues to keep interest rates and inflation low. Low interest rates benefit consumers, in that they can buy a new home, refinance their mortgage, consolidate personal debt, all at extreme low interest rates.
It's worth noting while that's a major plus for consumers, the obvious downside is what investors are able to earn on their high yield savings accounts, checking accounts, and bonds. Interest rates have been low for a considerable amount of time, that getting paid more than 1% on a savings account or money market account is a distant memory for most.
Low-interest rates also help corporations, helping keep costs down, and profits up. As profits continue to soar, that's when you see the stock prices increase as well.
The other big factor affecting the stock market is the technology sector, which has been the main influencer for the overall stock market. Where energy, real estate, and consumer discretionary stocks have suffered during the pandemic, technology stocks are experiencing some of the biggest increases.
For example, the FAANG stocks represent a large majority of the total market cap of all U.S. stocks. These are: Facebook, Amazon, Apple, Netflix, and Google. Not to be undone are newer tech stocks like Zoom, Shopify, and Spotify, who have also benefited greatly from everybody being home during the pandemic.
There was a time where you could look to the news and get a sense of where the market might be going, but in this economy, with a global pandemic like we have never experienced, all of that previous logic is thrown out the window.
Despite the uncertainty, now is a good as time as ever to invest in the stock market. Just make sure you’re working with a qualified professional that can assist with all of your financial needs.
Jeff Rose is a combat veteran, certified financial planner and founder of GoodFinancialCents.com