It is hard to believe that one Economic Indicator will influence the stock market. That’s why there are over 50 economic indicators that are released every week , month or year that cause drastic movements in the stock market. Every economic indicator has a different track record of predicting upturns and downturns in the economy. The state of the economy (and business cycle) can be used as a tool to invest in specific sectors and businesses. Information regarding the economy (through economic indicators) is highly sensitive and is only released in tight lock-up conditions – to prevent market participants from misusing and abusing it. For instance, masses may trade based on inside information of economic indicators, thus gaining an unfair advantage. Information regarding five indicators and their influence on the stock market will be spread across 2 separate blogs. In this blog, we will only be focusing on the first 2 indicators.
The main reasons for selecting these 5 economic indicators are–
- Their Accuracy – The data is collected using a large and representative sample of the population. In addition, a large proportion of the people that are queried/surveyed come back with answers.
- Their Timeliness – The data provided by the indicator will not be out-dated and provide current and fresh information about the economy. Current data is crucial and is likely to cause larger increments or decrements in the stock market.
- Their ability to predict –Some indicators are better than the others in predicting upturns and some indicators are more useful when it comes to predicting downturns. We will look at indicators that have successfully predicted turning points in the economy and can be relied upon by market participants.
Business leaders may focus on the employment rate, bond traders on interest rates and investors on changes in business and consumer spending. In this blog, we will focus on economic indicators that influence stocks (or which investors focus on).
We now present to you the top 5 economic indicators. These indicators can be used to predict the overall state of the economy and corresponding state of the stock markets . The indicators that we will be focusing on are sensitive to stocks.
| No. | Indicator |
| 1 | Employment Situation Report |
| 2 | Consumer Prices |
| 3 | Consumer Confidence |
| 4 | GDP |
| 5 | Personal Income and Spending |
Employment Situation Report –
This report (indicator) provides useful insights into the unemployment rate , daily wages , participation rate and population (breakdown by age)etc. It also tells us whether the economy is generating enough jobs for the increasing population. If an increase in population is not followed by companies hiring more people , not enough jobs will be created and this can cause negative sentiment. On the flip side , if jobs increase , this will lead to consumers spending more and stocks may skyrocket. However , it is important to point out that consumers may spend on a limited number of goods and services. That is why economic indicators must be used in conjunction with each other. In this case , it is imperative to use the personal spending report(where a detailed breakdown of the goods spent on is provided) . After all, there is little point in buying a stock of a company whose products are not in demand – even during a period of high incomes across the entire economy.
It is important to note that the report will also highlight the causes of unemployment. Unemployment that is caused due to businesses temporarily shutting down businesses is unlikely to cause any harm as over time, businesses may see an increase in demand for their products . However , unemployment due to non-temporary(this includes some firms closing their doors for good) or long term factors may be a cause for concern and can also foreshadow a recession. Moreover, a positive employment report points to an increase in stock prices.
Dow Jones Industrial Average vs. Unemployment –
Consumer Price Index (cpi)-
Just like the employment situation report , the Consumer Price Indicator is an important and red hot tool that investors use to generate a snapshot of the entire economy and understand how stocks may respond to inflation(in certain sectors). It essentially refers to the cost of living of people. Of course , costs of living may vary from household to household. Therefore , it mainly covers the average change in retail prices over a certain period of time(example – one year). For instance , it may cover the total change in prices of household items such as fuel and utilities. An increase in the consumer price index means rising inflation. Inflation is a double edged sword , however, its drawbacks outweigh its benefits. Inflation may allow a business to generate more revenues by charging higher prices. This can increase stock prices. Inflation can help the government generate more tax revenue , thus allowing it to spend more. Large borrowers repay their loans with cheaper dollars.
In contrast , inflation may cause uncertainty among households and can increase the costs of production of companies. Falling prices or deflation can be equally as harmful as inflation. Low employment can reduce spending . Corporate profits may fall. However, deflation resulting from advancement in technology and production methods is beneficial for the economy. Therefore, the government aims to achieve price stability and prevents the economy from slipping into extreme levels of inflation or deflation.
The Consumer Price Index may help business forecast costs of production. Sharp increases in the CPI may lead to higher bond rates , thus making it expensive for companies to borrow. Also , investors expect companies to make profits by improving sales and not hiking prices. A rising CPI will also trigger higher interest rates and this can be quite devastating for firms and shareholders.
Consumer Price Index vs. Sensex –
Consumer Price Index –
BSE Sensex –
From the graphs above, it is evident that a decrease in CPI will trigger a rise in stock prices and an increase in CPI will trigger the fall of stock prices. However, it is important to note that CPI figures must be compared to the expected CPI figures. For instance , if masses expect the CPI to increase by 5 % and the actual CPI increases by only 3% , there will be a positive impact on the stock market. On the other hand, if the actual increase in CPI in greater then the expected increase , there may be a negative impact on the stock market.
*The information provided by Finance Voyager is for information purposes only and is not intended for advice. Finance Voyager also does not make any recommendation or endorsement as to any investment, advisor or other service or product. The information is only for educational purposes and not buy or sell recommendations.