The Top 10 Economic Indicators – What to Watch & Why – Even before getting into the content, the above topic is subjective, not to mention that it could be fairly misleading. Here’s why?
- Let me tell you fair and straight that there are easily more than ten indicators. You could argue in your favour by singling out the word “the” in the beginning of the topic. It is like composing a poem about ‘The Flower’ without actually mentioning which flower is being referred to, leaving you to guess which flower it is. Similarly this topic is subjective by nature.
- I, the writer may not be the best in the subject simply because no one is the best when it comes to the field of finance and economics. Many people might be great, but not all are right at all times – so don’t bother much about IQ. Thus, the ten indicators mentioned might not be the best indicators at all times. Is Roger Federer the greatest tennis player ever? Or regarding this subject, is Warren Buffett the best investor ever? If you are an investment expert, your top ten might be different not only from mine, but also from Mr. Buffett’s.
- The third reason is subtle yet blatant because this would interest you, the reader to believe that this is the key to success in your investment decisions. So here is the disclaimer you have not been hoping for – the indicators mentioned are generally looked at indicators and could be used to make investment decisions at your own risk. The pleasure is mine to point this out to you.
Having gone through the caveats above, there are a few other things to note:
- The following ten indicators are in fact, quite critical in today’s times given all the imbalance occurring in the financial world. Read the papers and you would know about a lot of global events. In order to have a good recap of the events making news, they have been used as examples to support the ten indicators which you will see.
- The given indicators will try to cover as much as possible by including several other factors that form part of an indicator to help appreciate their interrelatedness.
- Given these ten indicators are subjective, some of them may not be found in another article if you Google the same heading. To specifically note, the ones mentioned here are not from a collection of multiple Google searches.
- I sincerely hope that reading this would enhance your knowledge and make you start looking at the financial world differently.
- The indicators mentioned are not in order of ranking since ‘beauty lies in the eyes of the beholder’ – beauty often lies.
So let’s begin with the real interesting stuff after the cautious and verbose introduction – the top ten indicators to watch out for and why you should watch out for them [according to me, the writer]. Two things to note before we begin – a leading indicator is one that helps determine economic changes and a lagging indicator follows economic changes.
- GDP and GDP Growth Rates
- Debt; Debt ratios and; Debt cycles
- Inflation and Inflation Expectations – Their friends & enemies
- Exchange Rate Stability
- Interest Rates – Policy Rates and Treasury Bond Rates
- Gold Prices and other metals’ prices
- Stock Markets and Volatility
- Risk Premiums
- Budgets; Deficits & Surpluses and; FDI Flows
- Crude Oil Prices
The Top 10 Economic Indicators
#1 – GDP and GDP Growth Rates
A lagging indicator generally, they are a fundamental factor to look at. Look at finance news, and you’d notice that the IMF or some other institution has revised their GDP growth rate forecast of a country. GDP or the Gross Domestic Product is the monetary value of goods and services produced in the country.
Why this economic indicator is?
Not only because they are seen as a fundamental factor by top institutions are they important, but in a way, the country’s worth could be represented by the GDP. The growth rate in GDP if consistent, is obviously considered good. Recently there have been debates about India’s GDP growth rate as it is considered the fastest growing economy in the world. It creates further complications if the authenticity of fundamental numbers is in question. On a worse note, China’s GDP numbers have not been considered correct for a number of years which also includes the time when they were the fastest growing economy.
#2 – Debt; Debt ratios and; Debt cycles
This is a leading indicator. A fairly large topic in itself but very important, debt is essentially borrowing money and comes in two forms: Private debt [debt issued by corporates and other institutions, loans taken by individuals/group(s) of individuals] and Public debt [borrowings by government(s)]. The money borrowed can be used in many ways depending on who is issuing debt – to finance asset purchases, to pay equity holders, to fund projects, to take levered risks on trades etc. When there is more borrowing than the ability to pay down the dues [preferably through legitimate income!], debt becomes risky and could lead to restructuring it for the good and in the worst case, debt defaults or failure to pay down the amount(s) due. Thus, there is a limit to how much debt can/should be taken. Other ways in which debt can be taken is either domestically or from abroad.
Debt ratios depend upon who is taking debt and varies from Debt-Equity ratios to Debt-GDP ratios.
Debt cycles come in the form of short term debt cycles lasting around 5-8 years (the 2008 financial crisis marked the end of a short term debt cycle which started after the dot com bubble) and long term debt cycles which may come once in a lifetime. It is believed that the Great Depression of the 1930s marked a period in the long term debt cycle which ended in the 1940s where World Debt-GDP shot to around 280%. Again in 2013, the ratio stood at around 360% and is believed to be slowly coming to an end. It is a very interesting topic which is given attention by Ray Dalio, CEO of Bridgewater Associates.
Why they are?
Post the 2008 financial meltdown, lower interest rates were almost forced upon in many economies to spur growth and investments. This incentivized borrowing and debt filled economies but sadly with little growth. As mentioned World Debt-GDP was almost 360%. China which was arguably the best performing economy after the crisis, given its terrific growth currently has a massive Debt-GDP of around 280% – the highest by any economy. The worrisome part is that China is slowing down although its Debt is currently seen as serviceable due to its FX Reserves, past growth income etc. Excess debt with low growth would lower the sovereign’s credit rating apart from causing multiple problems.
Similar debt related sorrowful episodes are faced by many economies – recently Puerto Rico defaulted on its sovereign debt. In the recent past Argentina and Greece have come close to being debt defaulters and; the 1998 LTCM hedge fund crisis saw Russia defaulting on its sovereign debt amongst several other examples.
#3 – Inflation and Inflation Expectations – Their friends & enemies
While you may think there isn’t much explanation to do about inflation as you already know it, you could be mistaken. Inflation takes different forms and to me is a vague indicator (which I wouldn’t like to delve into) but has been and will be a really important one for economists, the economy, policy makers, investors and traders alike. Apart from the various types of inflation, the metrics commonly used are the Consumer Price Index [CPI], Wholesale Price Index [WPI], Personal Consumption Expenditure [PCE] and the GDP Deflator. In general, excessive inflation can cause a fall in the exchange rate, high interest rates to curb it, demand and supply side issues and blowing-up of prices – economic terrorism where everyone is a hostage.
Inflation expectations determine the way inflation would evolve in the future. It is calculated in many ways. To mention a few, the 5 year rate in 5 years’ time [aka 5 year 5 year forward] on interest rate swaps and the medium term forward rates on treasury inflation indexed bonds or TIPS [Treasury Inflation Protected Securities].
Friends and Enemies: Indicators like the wage-price index, jobs growth, unemployment numbers, payroll numbers can at times, add an upward push or take a toll on inflation. They are lagging indicators of economic stability. Just for the record, an indicator you’d like to see is the Philips Curve [a graph which compares unemployment rates and inflation].
Why they are?
In the current environment of slow growth and disinflation (not to be confused with deflation), inflation is considered vital. The US, UK, Eurozone and Australia have been under the disinflation scanner. In the past, hyperinflation was the fear. US inflation in the early 1980s almost touched 15% and Paul Volcker, the then Fed Reserve Chairman raised interest rates (fed funds rate) from around 10% to 20% and what followed was a recession like environment. Inflation is a basic indicator to see whether your country and other economies are in shape or not.
#4 – Exchange Rate Stability
The word ‘stability’ is important here. Exchange rate is in general compared with the US Dollar. It tells us how much one unit of the US Dollar [USD] would fetch in terms of the domestic currency. For example, India’s exchange rate stands at Rs.67 per US Dollar. Within exchange rates there are two areas we must focus on. Nominal Effective Exchange Rate [NEER] which adjusts the exchange rate, weighted according to trade with other countries. Real Effective Exchange Rate [REER] adjusts the exchange rate comparing it with a basket of other currencies adjusted for inflation. That’s enough to know about right now!
Why they are?
Central Banks sometimes depreciate their exchange rate to boost inflation and enhance exports and appreciate the exchange rate to do the opposite. Over time if exchange rates keep falling, it gives a signal that the country isn’t in a good position and investors are backing out of them. That leads to further depreciation and causes a lot of instability which may be difficult to sort out. I remember a time when the Indian Rupee [INR] was at Rs.45 to the USD which seemed normal. Now it stands at Rs.67 to the USD and seems normal. But there was a time in 2014 when the INR was falling heavily and one would argue that it is still falling a lot. But on an REER basis it has performed better than other currencies which is why the INR is one of the better performing currencies over the last few years. But the Brazilian Real and many other currencies have performed quite poorly underlining the state of their economies. You would know about the Chinese currency devaluation so to speak in August 2015 from a band around CNY 6.20/$ to approximately CNY 6.32/$.
#5 – Interest Rates – Policy Rates and Treasury Bond Rates
This is real simple but critical stuff. Monetary economics and policies suggest that interest rates majorly drive economic activity. Although it can be argued, they are one of the most important factors. Policy rates set by Central Banks have been seen with even more interest and expectation than Roger Federer winning an 18th Grand Slam. Even a fractional move nowadays is seen as an anticipated big boost or a bust. Policy rates are both, a lagging and leading indicator to be honest. When the interest rate [nominal rate] on deposits/securities is adjusted for inflation rates, we get the real rate of interest which is left uneroded by inflation [Nominal rate minus the inflation rate is approximately the real rate]. Stable interest rates both nominal and real, relative to exchange rates, inflation and other economies is seen as a signal of strength [for whatever it’s worth]. its???
The Treasury Bond or T-Bond rate which is generally the 10 year rate [and is considered the benchmark risk free asset] is also a major indicator and can tell you whether the environment is in a recession. Sometimes, diversions and correlations between T-Bonds and the stock market can yield crucial conclusions for traders.
Why they are?
Of late, the 10 year benchmark Treasury Bond of Germany, Switzerland, Japan and a few other countries have been yielding negative interest rates [you lend money and get paid back less when the amount is due – Crazy enough, but that’s the world we live in]. Negative policy rates in countries suggest poor economies and very low to negative 10 year bond rates can indicate a heavy safe haven investment or a possible recession if the treasury yield curve is downward sloping. During the financial crisis of 2008 we’ve known about, credit spreads blew over the roof and caused corporate distress and defaults.
#6 – Gold Prices and other metals’ prices
Gold is considered a safe haven asset and tends to go up in value if there is a recession like tendency in the world economy just like prices of US and German T-Bonds. Although there are deeper facets to understand in gold price movements, other Precious Metals like silver and platinum prices also must be looked at to confirm our take on gold. Several studies on correlations between these metals have been done. Arguably, gold is also considered a hedge against inflation in an economy.
Why they are?
In December 2015 odd, gold prices had almost touched $1050/oz. The changing critical complexion of the world from moderately safe to risky caused heavy allocation of money in gold and it currently trades in the range of $1350/oz.
#7 – Stock Markets and Volatility
A leading indicator, they are the first thing that comes to our attention in the morning if you’ve got money at stake. It reflects the sentiments of investors and traders alike, on the companies that form the stock index and the macro decisions that affect these sentiments. Volatility is the risk we see due to large fluctuations on either side of the index but is tilted more to the downside – market volatility is measured by the volatility index.
Why they are?
Being important indicators, they shouldn’t be looked at in isolation. In July 2015, there was some inconsistency observed between the US Volatility Index and the premiums on Credit Default Swaps [CDS contracts are used like insurance to protect against events of default] as they generally move in tandem. The 2008 crisis, Brexit referendum’s outcome on June 23rd 2016, the Dow Jones crash of 1987 are some examples of volatility that markets hadn’t imagined of! At times, the Volatility Index and T-Bond yields have moved in tandem which might give you a sense of mispricing in asset classes – since greater volatility makes people invest money in safe securities like T-Bonds, thus pushing their prices up and yields down (bond prices and yields are inversely related). A good indicator right?
#8 – Risk Premiums
Risk Premiums are generally lagging indicators and give you a sense of the perceived riskiness of different securities/index. Simply put, they are the extra expected return you get for facing volatility and risk of a security or index. On a macro basis, higher country risk premiums indicate higher expected returns but with a higher risk. When coupled with slow growth and other slowdowns, this could affect the country’s credit rating given by credit rating agencies like Fitch, S&P, Moody’s etc.
Credit Spreads/premiums are indicative of the extra yield required on debt securities with risk versus a comparable T-Bond rate which is considered risk-free. A higher spread indicates higher perceived risk in the economy. Other important types of risk premiums to look for include liquidity premiums, optionality premiums, CDS spreads and inflation premiums.
Why they are?
During the credit crisis of 2008, credit spreads blew over the roof. Below is a chart of CDS premiums around the 2008 crisis. Here, they were an indicator of credit risk in the economy building up.
#9 – Budgets; Deficits & Surpluses and; FDI Flows
A good government that takes progressive steps and tries to achieve its budgetary targets are generally rewarded and what follows is good stock market performance, possible FDI [Foreign Direct Investment], a better credit rating etc. A higher deficit has to be financed and is generally done by issuing government debt, thereby raising money. This again gets linked to the debt spiral and weakening exchange rates. A surplus would reduce debt but may reduce the incentive to push reforms ahead given that the economy seemingly looks strong. Strong and consistent FDI flows are an unambiguous good while weakness would indicate a drop in bullish sentiment.
Why they are?
Japan runs a Current Account Surplus but have been sent to the cleaners for the last 20 odd years in terms of economic growth and seems to be a losing proposition to invest in. The UK seems to be reeling with their Current Account Deficit [CAD – not to be confused with the Canadian Dollar which is also CAD]. India has cut down their CAD from around 3.5% of GDP to 1.4% of GDP attributed mainly to lower oil prices – this has again increased investors’ sentiment towards India.
#10 – Crude Oil Prices
This has become even more important since crude oil fell from around $120/barrel to $50/barrel in 2015 and then to less than $25/barrel early 2016. If you weren’t aware of it, here’s a graph for you!
Crude oil is a major component which tends to affect crude importing economies and energy related industries positively when its price falls if they are net importers and negatively if they are net exporters.
Why they are?
Due to the fall in oil prices, countries like India have benefited from the fall in their CAD while others like the Gulf nations, Russia and Venezuela have faced heavy currency volatility and deficits due to their dependence on oil, being exporters. Given the fact that the OPEC [Organization of Petroleum Exporting Countries] still dominate control over the price of crude, stubbornness to cut down production which will lead to a rise in oil prices is creating a problem. This is because they are competing against an alternative resource known as Shale Gas and amongst themselves, especially Saudi Arabia and Iran.
We have possibly covered the whole gamut of economic indicators to be given importance in every heading. Technically, there are easily more than 10 economic indicators mentioned. Keep in mind that political factors are equally important and to be coupled with the economic ones.
The most important economic indicator to choose from the above ten? Combining all of them to come up with your independent stance is the best and most important of all. Good luck working on that!