Essential Macroeconomic Metrics for Informed Investment Choices
A smart investor always analyses the investment opportunities in various industries and the economy as a whole. For this, the smart investor looks at macroeconomic indicators to get the closest prediction of the possible changes in the economy of a country and the global economy. Economic indicators give insights into the health of the economy. Macroeconomic indicators provide insights into whether the state of an economy is at its expansion stage or its contraction stage, popularly known as recession. Furthermore, macroeconomic indicators provide pieces of information to analyze current and future trends of investment.
Investors may look at a micro level such as at the level of input used and output produced from an individual company or from a single industry, which does provide quite sufficient insights to investors. However, to go beyond, insights into macroeconomic indicators are vital. The macroeconomic indicators quantify various aspects of the economy, everything ranging from indicators of unemployment to economic growth to changes in the prices of commodities. These quantified pieces of information can provide insights into 3 categories of the spectrum:
A) Leading Indicators
They could be leading indicators, which predict future trends and movements of the economy. Investors can use these economic indicators to identify opportunities. However, the opportunities could be classified to be risky, as the predictions of the future are highly uncertain. These indicators represent the beginning of a new economic cycle. Governments often use these indicators to implement policies. Leading indicators are true companions to policymakers and investors to predict the revenue their strategies and decisions may generate.
B) Lagging Indicators
These indicators reflect the historical performance of an economy. In addition to this, these indicators only change after a trend has been confirmed, in other words, these indicators are released after the economic activity has occurred. These indicators include GDP, inflation, and employment rates. However, to some investors, these indicators may not provide insights to identify investment or even trading opportunities, but these indicators provide a snapshot of the health of the economy. Investors are especially known to use these indicators to analyze market trends, tools for business operation strategy implementation, and signals to buy or sell financial assets. Some of the examples of lagging economic indicators are the unemployment rate and labor cost per unit of output.
C) Coincidental Indicators
These indicators show real-time glimpses of the economy. They are the results of certain economic activities which apply to a particular area or reason. These indicators either occur at the same time or after an economic shift. These indicators are usually complementary to lagging indicators and leading indicators to give a full picture of where the economy stands and where the economy is expected to be in the future. These indicators show if the economy is in its expansionary stages or recessionary stage in the business cycle or economic cycle. The quantified economic information that falls under this category is Personal Income (PI), manufacturing and production, and cycles of the industry, to name a few.
Here, we have listed 10 key macroeconomic indicators that investors should look at before investing:
1. Gross Domestic Product (GDP)
GDP quantifies the monetary value of all goods and services produced within the political boundaries of a country. GDP is mostly used to compare the different countries. It assists in predicting the growth of economies. This indicator is most watched by the financial markets when making investment decisions. The market actively responds to every GDP shift. Often in the economy, stocks and indices increase or decrease with the GDP. GDP tends to show the amount businesses have made in the period. GDP is a top lagging indicator which indicates a stable economy when it increases consistently. When GDP increases, its spillover effect can be seen in other indicators such as employment rates and, manufacturing and production. Rising GDP indicates the economy is expanding while falling GDP rates indicate a contracting economy. Experts often criticize GDP as easily manipulated by the government to meet their objectives, nevertheless, it is still a key macroeconomic indicator.
2. Interest Rates
Interest rates are the percentage charged on loans or paid to depositors on savings accounts. The interest rates of an economy are set by a country’s central bank. The interest rates are then trickled down to commercial banks and consumers. Interest rates reflect the economy in many aspects, due to this the government uses it as a tool to re-adjust the economy.
Interest rates are increased to control inflation and reduced to promote growth at other times. Interest rates are one of the most influential factors for the forex markets, as they impact they the value of currencies. The higher the interest rates, the stronger the economy. This makes investors more likely to buy the currency of the stronger economy, which leads to rising values. The increased interest rates would mean a higher rate of return for savings in bank accounts, this would encourage people to save instead of buying higher-risk investments in the economy. Therefore savings increase in an economy while investment decreases. In the opposite situation, if interest rates fell, it would indicate the economy weakened. The currency of the economy would devalue and the interest on savings accounts would be reduced to make higher-risk investments worthy.
Interest rates are argued to be both leading and lagging indicators; they are lagging indicators in a sense, as they are the decision to increase or decrease rates made by central banks after analyzing and establishing that an economic event or market movement has already occurred. On the other hand, they are leading indicators in the sense that once the decision has been made, there is a significant probability of the economy changing to mirror the new rate.
4. Employment Rates
Employment rates quantify the number of jobs in an economy and how much each individual is being paid in return for their labor. It is often said to be the most important lagging indicator. If the employment rate falls over some time, it tends to indicate that the health of the whole economy has been declining. It implies that businesses have given up hope of improving the situation and have started to lay off their workers. Businesses will always wait until they are sure the economy is growing before they start to employ new workers. As employment rates present a snapshot of the health of the economy, it is considered to be a key indicator of the economy.
4. Consumer Price Index (CPI)
A consumer price index (CPI) measures changes in the cost of goods and services purchased by consumers in a specific month. In essence, it compares the cost of living over time and so can be used to measure the magnitude of inflation levels. Investors use this lagging indicator to find signals of inflation which changes prices in the economy and may hinder opportunities in the market. Rising inflation rates are often associated with higher interest rates and reduced borrowing. While falling interest rates indicate lower interest rates which subsequently increase borrowing in an economy. Every country has its own CPI, which reflects the position of stocks, indices, and currency of an economy or country.
5. Inflation
The continuous increase in the price of goods and services in a country or economy is inflation in that country. It is the result of an economic growth or decline. Therefore, this macroeconomic indicator is lagging as it is released after the economic activity has occurred. Investors should closely follow inflation trends to get a picture of the economy. Increases in inflation are associated with economic growth. While economic growth does seem like a positive indicator to invest, the reality of it could differ. A high rate of inflation can have a nasty impact on the value of a country’s currency, this subsequently decreases the currency’s purchasing power, making it more expensive for consumers to buy products in the country. The spillover effect of high inflation can be seen in other macroeconomic indicators as it reduces employment in the economy, reduces GDP growth, and raises the interest rates of a country. While the increase in interest rate is the result of high inflation, it is a tool used by the government to curb inflation and bring prices under control.
On the contrary, when inflation rates fall steeply, a phenomenon known as deflation takes place in the economy. This phenomenon indicates the economy is in its contraction or recessionary phase. During economic downturns, inflation rates may fall to 0% or even lower. This may sound better than high inflation rates, however, its effects are dreadful. During this time money is scarce, therefore spending is reduced this is often followed by a decline in demand for goods and services, reduced production, and reduced employment in the economy. This makes investing in such economies hopeless.
6. Manufacturing and Production
Manufacturing and production output can be one of the easiest and quickest ways to get insights into the state of the economy. This leading macroeconomic indicator suggests an increase in production and manufacturing outputs will tend to have a positive effect on gross domestic product (GDP) which is seen as a sign of increased consumption and positive economic growth. The change in production manufacturing output also has impacts on employment rates, as more output means business is doing well, hence jobs are available to produce even more. The higher the numbers of manufacturing and production, the better the economy is doing, and is beneficial for investments.
7. Stability of Home Currency and FOREX
A country’s currency reflects the health and stability of an economy. A currency’s price is based on demand for the currency from buyers and how sellers perceive its value. The currency’s value will change to reflect the political and economic circumstances of the country, therefore it is a lagging indicator. Instability in currency has detrimental effects on investments. Due to this, investors view countries with stable currency as a strong economy. A strong currency enhancements the economy as it increases the purchasing power of the people in the country. However, the impact of increasing currency prices depends on whether a country is a net importer or exporter, if a country is a net importer, it becomes cheaper to buy foreign goods and vice versa. In the opposite situation, when the home currency devalues, it encourages tourism and the demand for domestic goods.
8. Price Level
Commodity prices are considered good macroeconomic indicators because their market prices often change before other lagging indicators. When the demand for commodities increases in the whole economy, it indicates the economy is growing. As a result of increased demand prices of the commodities also increase. The increase in the price of different commodities may have varied impacts on the economy. An increase in demand for a commodity, such as wood, iron, and oil, is a sign that an economy is growing. These supplies are required to build infrastructure, and so the largest importers of these commodities are emerging market economies. When the price of commodities such as gold increases, it indicates an economic downturn. Investors generally store gold during periods of economic uncertainty. If the price of gold rises, it can be a sign that the economy is slowing, and investors are seeking stability.
9. Balance of Trade (BOT)
Balance of trade (BOT) is the difference between the amount of exports and imports of a country or an economy in a given period. An economy with higher levels of imports than exports is seen as having a trade deficit. While, a country with a higher level of exports than imports has a trade surplus, which is usually perceived to be a good sign for an economy. This macroeconomic indicator shows there is more money coming into a country than there is leaving it. This occurrence is known as a deficit, it signals domestic debt and even results in the national currency falling in price. Therefore, for investors, this macroeconomic variable helps determine if an investment in that economy is worthwhile.
10. Real Estate Market
The real estate market reflects the health of the economy, due to this it is considered a leading economic indicator. The indicator provides insights into the state of the economy in advance. A decline in the number of new real estate projects or a decline in the price of properties shows that few people are looking to buy. A weak real estate market usually causes a chain of reaction to the rest of the economy, it reduces property owner’s wealth, lowers employment in construction, and can force homeowners and property owners to default on their mortgages. The number of construction projects can be a leading indicator of economic health. The start of new projects is seen as an indication that companies expect demand for homes to rise. If construction projects start to decline, builders and investors tend to have a more negative view of the future of the market.
