The Impact of Economic Indicators on the Stock Exchange

Predicting trends has been every investor’s objective as long as the stock market has existed. This is particularly important for the small investors who must make the best of available resources to maximize returns on their portfolios. While economic indicators cannot guarantee future stock performance, they can offer a glimpse into the future that can mitigate some of the risks of trading.

Broad-Based Indicators

Since all businesses are affected by the overall economic climate, macroeconomic indicators that foretell economic activity will impact the stock market. The Conference Board, a 501(c)3 nonprofit organization, maintains an index of 10 leading indicators. This index suggests the direction the economy will take six to eight months down the road. The direction of the index -- and its individual components -- is generally reflected in the movement of the market. Another source is the "Beige Book," published by the Federal Reserve eight times a year. Although not an economic indicator per se, the "Beige Book" offers the Fed’s view on the future of the economy as a whole and for each of the Fed's 12 districts.

Major Indicators

The three indicators that most investors rely on to project long-term trends are the gross domestic product, or GDP; the unemployment rate; and the rate of inflation. The GDP is the value of everything produced in the U.S. during a year. Released quarterly, the GDP's growth rate is an important gauge of future economic activity. The GDP needs to grow at a rate of at least 3 percent to create jobs. Anything less than that will portend a sluggish economy, which will be reflected in the market. The Labor Department releases two unemployment statistics. The weekly number of people filing for unemployment for the first time gives a snapshot of the state of the labor market, but the labor statistic that is most watched is the monthly unemployment rate. The consumer price index measures inflation by showing the month-to-month change in the price of a “market basket” of goods and services that consumers typically purchase. A low level of inflation is common. If the inflation rate begins to rise, however, rising costs will hurt profitability and depress stock values.

Other Indicators

Consumer confidence and manufacturers’ new orders reflect activity in the two largest sectors of the economy and have a corresponding impact on the stock market. Consumer confidence is an important measure of the economy’s health, because 70 percent of the GDP is based on consumer spending. Manufacturers’ new orders is an indicator that foretells the confidence of the business sector and its willingness to commit to new purchases. Significant changes in either of these will certainly influence the direction of the stock market. Market watchers anticipate economic data closely, and if the data releases vary from their expected levels, they will have more impact on the market. An unexpected rise in consumer confidence, for example, will likely boost the market. Other indicators abound, and the individual investor can find others that will serve his purpose.

Predicting the Stock Market

Indicators that bode well for the economy are likely to fuel growth in the stock market. While positive indicators do not automatically guarantee positive stock performance, historical precedents exist. A growing GDP -- buoyed by rising consumer confidence, stable or falling unemployment, low inflation and strong new orders from manufacturers -- presage a bull market.

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