Every week there are a variety of indicators released to gauge the health and direction of the economy. With so many numbers and so much information, it is sometimes difficult to know what to watch and why. The media has a habit of reporting figures without much context, so I thought it would be a useful exercise to discuss the most important indicators and what exactly they mean.
So what should you watch? Generally, economic indicators fall into three categories – leading indicators, coincident indicators, and lagging indicators. This week, we’ll focus on leading indicators, and cover the others in the coming weeks.
Leading indicators indicate which way the economy is headed. Some prime examples are unemployment claims, the Consumer Confidence Index, the Federal Open Market Committee Statement, and housing starts.
Weekly claims for unemployment
Weekly claims for unemployment is the number of workers filing for unemployment benefits after losing a job. I check both the US BLS (Bureau of Labor Statistics) U3 number which is typically the ‘headline rate’ we see quoted in the media, and more importantly the BLS U6 number.
U3 measures the unemployment rate, which is defined as people who are without jobs and have actively looked for work within the past four weeks. U3 does not count ‘discouraged workers’, or those who are unemployed but no longer seeking employment.
U6 gives a fuller picture of unemployment. It includes the unemployed from U3, in addition to ‘discouraged workers’, ‘marginally attached workers (those who would like to work but have not looked recently), and part-time workers who would like to work full-time but cannot due to economic conditions.
Market sensitivity: High (monetary policy, stock and lending is affected by this number)
Release time: 8:30 AM ET every Thursday, covers the week ending the previous Saturday.
Source: Bureau of Labor Statistics
Why it is important: The initial unemployment claims report has proven to be a good indicator of when the national economy is approaching a turning point. Experts pay close attention to this indicator due to the accuracy and timeliness. It accurately reflects what is presently going on in the economy. For example, if a large number of people are losing their jobs every week and applying for unemployment compensation, this will eventually dampen consumer spirits, slow their spending, and cause businesses to pare back investments. On a regional and local level it shows the economic health of the area. As we all know by now, Texas and its metros have had a phenomenal run during the recession and presently. When the local unemployment is doing well it has a tremendous impact on restaurants, retail, office, commercial, etc. A healthy unemployment number is somewhere between 5 and 6%.
Consumer Confidence Index
The Consumer Confidence Index examines consumer expectations about the economy (how they feel about jobs, the economy, and spending), as reflected by a survey of 5,000 U.S. households conducted by the Conference Board.
Market sensitivity: Medium, but can be high at turning points in the economy.
Release time: 10 AM ET, announced the last Tuesday of the month being surveyed.
Source: The Conference Board – The Conference Board is an objective, independent source of economic and business knowledge for its clients
Why it is important?: Happy consumers are good for business. When consumers have confidence in the economy they are more inclined to spend. When they are confident about their job and their company, they are more likely to shop, travel, go out to restaurants, invest, buy homes, and keep the economy on a roll. The opposite obviously is lousy for business, and if the number of malcontents in large enough it can derail an economy.
It is a highly subjective survey, and the results should be interpreted as such. People can grab onto a small situation that garners a lot of mainstream press, such as gas prices, and use that as their basis for overall economic conditions, fair or not. There are no real data sets here, and people are not economists, so they cannot be counted on to realize that, for example, because gas prices may only represent 5% of their expenses, they should not sour their entire economic outlook.
Analysts and economists look for the index to be somewhere between 85 and 110 to be a healthy outlook for the consumer.
The Federal Open Market Committee Statement
Market sensitivity: Very high
Release time: 2:15 PM ER on the day the FOMC concludes its meeting. A schedule of its meetings can be found at www.federalreserve.gov/fomc/.
Frequency: The FOMC formally gathers eight times a year and issues a statement on the results of its deliberations at the conclusion of every meeting. Only in the most extraordinary circumstances might the FOMC choose to act between scheduled meetings.
Source: Federal Reserve Board
Why it is important: Understand that this statement is issued from the US central bank, the Federal Reserve, an institution that is structured to be above the political manipulations of Congress, meaning that it statements are taken with a sense of gravity about the seriousness of report. The brevity of this report belies the enormous impact it has around the world. This is a report that barely fills a single page, contains virtually no numbers, and comes out just eight times a year. The FOMC statement is studied word by word by economists, analysts, investors, and the business press. Words or phrases that showed up in previous releases but are omitted in the current statement are studied to capture all the possible nuances on how the Fed currently view the economy.
How do you read the FOMC statement? Slowly and carefully.
First, there is a short introduction sentence that tells the outcome of the FOMC vote on interest rates, which currently are at their lowest in over 60 years. The delay of QE2 had a tremendous positive impact for the markets last week.
Next, there is a brief section describes the economy’s current state based on the latest economic indicators. After that, there is the part that reviews and highlights the Fed’s assessment of current inflation and growth. This is the part where economists, analysts and investors get a sense of what the FED will be inclined to do when it meets next. This paragraph is more forward looking and offers some insight into what the FOMC will monitor most closely between now and the next meeting.
Finally, there is a list of FOMC members who participated in the meeting that morning and how they voted. Generally (particularly with interest rates) the preference is to have unanimity among the members in line with the Fed Chairman. There are occasions when certain participants disagree so strongly with the Fed chairman’s recommendation they will formally register their disapproval.
Housing starts refers to the number of new homes being built and permits for the future construction. In a healthy market for every two new jobs there should be one housing start. If housing starts start to outpace job creation, I begin to worry about speculative building.
Release time: Normally released 2 to 3 weeks after the month covered.
Source: Census Bureau, Dept of Commerce
Revisions: Modest revisions normally occur for the proceeding two months on housing starts and one month on permits. Seasonal adjustments are made every April.
Why it is important: There isn’t a single indicator that can foresee the future direction of the economy. However, of all the indices this one comes surprisingly close. Excluding one brief instance, there has never been a recession in the US at a time when the housing sector stood strong. Only once since WWII did the economy contract despite a robust housing market, and that was in 2001. Even then, the recession was short-lived and not very deep. This impressive track record is why may economists and experts view homebuilding as one of the most reliable leading indicators of economic activity. Residential real estate is among the first sectors to shut down when the economy nears recession, and it is the first to show growth when the economy begins to turn up.
What makes housing so far ahead of the rest of the economy? Sensitivity to interest rates and credit and confidence in the future economy. A strong economy drives interest rates higher. As mortgage rates climb, demand for new homes slows. Builders are less likely to seek loans when rates are high.
Another critical aspect of the homebuilding industry is how powerful an influence it has on the rest of the economy through what are known as “multiplier effects” (how much one dollar moves through the economic chain). New construction has major ramifications for many industries. A jump in residential construction drives up demand for steel, wood, electricity, glass, plastic, wiring, piping, oil, concrete, etc. Locally there is the need for skilled labor, slab and flatwork, carpenters, electricians, truck drivers, forklift operators, etc. In turn, laborers spend their wages in the local economy, bolstering retail, hospitality, and services. An estimate is that for every 1,000 single family homes under construction, some 2,500 full time jobs and nearly $100 million in wages are generated.
How are housing starts counted? Housing starts is the number of privately owned new houses (technically housing units) on which construction has been started in a given period. This data is divided into three types: single-family houses, townhouses or small condos, and apartment buildings with five or more units. Each apartment unit is considered a single start. The construction of a 30-unit apartment building is counted as 30 housing starts.
Why housing permits? 95%+ of all localities in the US require construction firms to obtain authorization before the first shovel touches the soil. By tracking the issuance of permits, one can get a sense of how much and where future construction activity will take place. Because housing permits are such an excellent marker of future homebuilding and economic strength, they are one of the ten components that make up the Conference Board’s Index of Leading Economic Indicators.
How is it computed? The Census Bureau conducts telephone interviews and sends out mailers to builders in 19,000 municipalities across the country during the first two weeks of each month to inquire about the number of construction starts and permits filed in their regions.
This indicator has broad effects on financial markets – bonds, stocks, and the value of the dollar can be impacted by this stat.
Bonds: Good news in housing is often perceived as bad news for the players in the fixed income markets. A healthy increase in housing starts depicts an economy that is robust and where inflation pressures are likely to accelerate. That has an effect that knocks down bond prices and causes yields to rise, leading to losses on bond portfolios. Most bond traders prefer weak or falling housing starts because they show a slowing economy with less inflation.
Stocks: Prolonged weakness in housing starts can alarm stock investors since historically it has been a precursor to a broader downturn in the economy. If the market is vibrant and inflation remains contained, shareholders will view it as a positive sign. As explained earlier, a rebound in new home sales has a beneficial impact on other businesses as well. This is bullish for corporate profits and stock prices. The caution comes when housing starts surge at a time when the rest of the economy is already operating at full speed. Investors historically withdraw from stocks as worries mount that the Federal Reserve will raise short term interest rates to slow the economic activity to prevent hyper inflation.
Dollar: Investors are attracted to the US if they can earn a higher return here relative to what they can receive in other countries. A strong housing report is considered bullish for the dollar because it historically supports higher corporate profits and a firming of US interest rates.
This may be way more than you wanted to know. But as you look to buy, sell or invest in real estate this economic primer hopefully will help you make a better decision.