So let’s imagine that you are all excited about that upcoming vacation to the Caribbean and getting all your packing done. Have you taken the time, however, to check on the weather forecast? What if that tropical storm was suddenly gaining strength, heading towards your destination, and developing into a full hurricane? Wouldn’t you want to know that before you left on the trip? Well I am suggesting that an investor should also be checking the economic forecast before putting those funds to work in the investment markets. So how do we know just how favorable or unfavorable the economic conditions are and how does one go about finding that type of information?
The key indexes that economists and market analysts are focusing on are known as the leading, lagging, and coincident indexes. Their significance is that the leading economic index points to future trends and turning points, the coincident index identifies those events that are in the process of developing, and the lagging index confirms that the previous events that were predicted have indeed occurred. The information provided by the indexes in the form of charts, commentary, and tables are helpful in explaining the different phases and where we appear to be in the business cycle. That full cycle reflects a period of economic expansion, followed by recession, economic contraction, and then a return to the expansion phase.
Each of the indexes are made up of a series of cyclical economic indicators which typically will be seasonally adjusted. Some of the components need to be estimated. Without exception all the components will be adjusted at a later date. The leading index is made up of ten components. An example of one would be the average weekly hours worked in manufacturing. For the coincident index there are four components with an example being manufacturing and retail trade sales. Finally the lagging index has seven components with an example being the average duration, expressed in weeks that people are out of work, of unemployment.
Understanding where we are in the business cycle is critical to applying an investor’s best judgment for the deployment of investment dollars. For example, if the indicators clearly evidence that the economy is in a recession it would not make much sense at that stage to invest in a company that makes capital equipment since that is normally purchased to expand production. A recessionary stage would suggest consumer spending will be down and there will unlikely be little demand for additional product made by that equipment.
If I have inspired you to consider doing more homework before investing let me refer you to a website where the information I have referred to above can be obtained. That would be www.conference-board.com. The indexes are published here in what is known as the monthly Business Cycle Indicators report and is usually released to the public at 10:00 A.M. four to five weeks after the end of the month to be reported.
Good luck with your homework assignment!
