Leading and Lagging Indicators in Online Trading

If you’re trying to set up your business for success, the first thing you’ll do is check the facts and figures describing its efficiency in past months. Once you’ve done this, you’ll have an idea of the areas in which it’s been underperforming and, perhaps, of the management decisions that haven’t been working out so well. Then, you can start developing your strategy for the future along the proper lines.

In developing that strategy, you’ll also be cognizant of the economic environment of the future, both in a broad sense and in terms of your particular industry. After all, that’s the context in which your business will have to function. In order to assess what this future will look like, you’ll need to be in touch with people’s perceptions of the business climate. The reason is that these perceptions will inform their financial decisions, which, in turn, will shape tomorrow’s world.

These two categories of data – those that look ahead and those that look backwards – are called, respectively, leading and lagging indicators and they are employed well beyond the scenario of an individual business. Notably, they are called up whenever analysts or central bankers are trying to assess the trajectory of the overall economy, or when stock traders are struggling to figure out where the market is heading. In both cases there is the need, firstly, to come to terms with the historical data as it stands and, secondly, to get an idea of the attitudes people are adopting towards the future.

In this article, we’ll discuss some of the most important leading and lagging indicators used by economists and traders. Our aims are to convey their usefulness in the realm of online trading, to assist readers in understanding which ones may address their needs best, and, finally, to suggest the most rewarding ways in which they might be utilized.

Let’s start off with the indicators that look backwards in time because, as Bob Marley says, “In this great future, you can’t forget your past”.

Top Leading Indicators For The Stock Market

GDP

A classic example of a lagging indicator is GDP (gross domestic product) in the USA – planet earth’s economic powerhouse. This number tells people the value of the goods and services the nation produced in a certain period of time, which could be a quarter or a year. The Bureau of Economic Analysis (BEA) sends out this statistic every month in the form of a percentage, which represents “the rate of change in real [inflation-adjusted] GDP from the previous quarter or year”. You can also find out the specific GDP change for a state, county, or industry by reading through the BEA’s report.

When GDP comes out strong, it means companies are seeing steady earnings come in. This boosts people’s confidence in the economy, which is usually bullish for stocks.

Inflation Rate

A popular gauge of inflation is the CPI (Consumer Price Index) index, which is issued by the Bureau of Labor Statistics (BLS). It gives a measure of the price changes people have been encountering in consumer goods. The CPI number, like GDP, is expressed as a percentage and represents the average change in prices over the previous 12 months. One figure published by the BLS relates to all consumer items; another one reflects the price changes in food products specifically; a third shows energy price changes; and the last refers to items excluding food and energy. It’s also possible to track price changes in specific food categories like dairy, soft drinks, meat, or baked goods.

When the CPI comes in high, showing that goods and services are getting pricier, it’s generally a positive sign for stocks. This is because inflation is characteristic of an expanding economy. However, there is a more nuanced impact too. If prices are rising, it means consumers will have to cut down on discretionary purchases like vacations and entertainment. This could lead to a pullback in related stocks, which would include those in the technology sector. In addition, elevated inflation levels can exert a blanket bearish effect on stocks when they influence the Fed to hike interest rates. Higher rates drain away the money supply needed for company growth, especially when it comes to tech firms.

Unemployment Rate

The BLS also takes on the task of reporting on the monthly unemployment figures in the US. In their news release titled The Employment Situation, they quote the number of unemployed Americans for the previous month as a percentage of the labor force. In order to do it, they survey a carefully chosen and representative selection of 60,000 households. Their headline figure is picked up by the media, but they report other data about their sample group too, namely, monthly and yearly salaries, job tenure, and the prevalence of poverty.

Higher numbers of unemployed Americans sap confidence in the markets, which works bearishly on stocks. By contrast, unexpectedly low unemployment numbers can act bullishly on Wall Street.

All of the above is well and good, but now it’s time to leave this sort of indicator lagging far behind. The first of our leading indicators takes these raw statistics and translates them into human attitudes and behaviour – which will sketch the outlines of the economic future.

The Yield Curve

The yield curve is a line that plots the yields (interest rates) of two types of US government bonds – the 10-year and 2-year Treasury notes. Strategists know that its shape can give us an idea of what the future will look like in terms of inflation, interest rates, and the general economic climate. Here’s how:

The yield curve “inverts” when the interest rates of 2-year notes exceeds those of 10-year notes, upending the natural order of things. When we see this happening, we have a pretty solid basis to believe a recession is brewing. In fact, every recession that’s occurred since the 1970s has been preceded by an inverted yield curve.

Practically speaking, the upside-down arc shows that bondholders anticipate the Federal Reserve will be holding the federal funds rate low on the long-term horizon. This is what reduces the longer-term rates below the short-term ones. Why do they expect such a thing? It’s because they spy an economic downturn ahead, to which the Fed will have to respond by cutting rates. “Then – to the degree these assessments are either correct or self-fulfilling – they will be useful in forecasting recessions”, explains the Chicago Fed.  

The yield curve remained inverted for an extended period, starting in July 2022 and continuing well into 2024, leading the New York Fed to conclude in March of that year that a recession was more likely than not within the next 12 months. Bloomberg’s John Authers wrote in June 2024 that “If the US escapes without a downturn, it will have been the loudest bond market false alarm on record”.

An inverted yield curve is considered a powerful leading indicator in trading, the reason being that stocks are likely to feel the pinch of a recession fairly directly. Specifically, it tends to be a trigger for bearish movement in the market.

Consumer Confidence Index (CCI)

The Conference Board (a think tank founded in 1916) use a different method of gauging people’s ideas about future economic conditions. They arrange a massive survey of over 36 million people, questioning them on their plans to buy homes, cars, gadgets, and vacations. The interviewers also ask people for their impressions of the economy as it stands, and of where it is heading. The Conference Board’s Present Situation Index reflects people’s beliefs about current business conditions, while their Expectations Index focuses more on their perspectives on what lies ahead.

Each index is expressed as a figure. In the Board’s report for June 2024, the reading for the Expectations Index came in at 73.0, down from the previous month’s number of 74.9. Aside from the significance of the drop in confidence, this made for the fifth consecutive month when the index held below 80 – the key level that, when breached to the downside, indicates a recession ahead.

The Conference Board also offer their interpretation of the index readings to help you assess their significance. Thus, in June 2024, their chief economist Dana M. Peterson explained that the rise in the Present Situation Index did not mean people were viewing business conditions in a more positive light. Rather, the strong labour market was rose tinting their impressions on this score. “However, if material weaknesses in the labour market appear, confidence could weaken as the year progresses”, she concluded.

The CCI is one of the most looked-to leading indicators in the stock market. When it comes in good and strong, the impact on market sentiment tends to be bullish. If consumers are feeling optimistic about their ability to make money, it means they are likely to spend more, which is exactly what Wall Street companies need in order to thrive.

Purchasing Manager’ Index (PMI)

The Institute for Supply Management (ISM) have a third method of assessing how people are feeling about the economy. They conduct interviews, not with large numbers of people, but with a very select group: the purchasing managers for manufacturers. It’s these individuals who are instrumental in deciding how much raw materials the manufacturers should purchase in order to meet demand. When they report their firms are expanding production, it shows consumer demand is robust. When production is cooling down, it means demand is cool too.

The ISM choose their interviewees from 20 industries so as to derive a representative sample. The kinds of things they ask them about include new customer orders, deliveries, production, inventory, exports, and imports. A feature in the ISM’s report that draws plenty of attention is the PMI, which summarizes the information they have gathered into a single digit. A PMI reading of 50 indicates half the managers reported expansion, while the other half reported contraction. If the number is below 50, it means contraction was the general order of the day. When it’s 51 or more, it signifies growth won overall.

You can catch the PMI when it comes out on the first business day of every month. On the third business day, the ISM send out another PMI tailored to the services sector. For May 2024, the ISM Manufacturing PMI came in at 48.7. Aside from failing to meet the 50 mark, this was also the 18th time in the last 19 months that the manufacturing sector shrank. Chiming in with the findings of the CCI and the shape of the yield curve, this made for less than heartening economic news.

The PMI is a popular leading indicator in trading. When market participants see the PMI reading is high, they take it as reason to be bullish since it means business is humming along nicely, carrying a stream of earnings to Wall Street firms.

Summing Up leading indicators in trading

We have familiarized ourselves with three of the most respected leading and lagging indicators in trading, explaining their significance with respect to the economy and the stock market. Bear in mind that the impact of leading and lagging indicators won’t always follow the rulebook. For all sorts of reasons, it won’t uniformly be the case that a low unemployment rate will translate into a bullish surge for stocks. Traders have to take the larger picture into account in each case, looking to other statistics and news reports to get the feel of where the market is heading. And, in using the leading and lagging indicators we have mentioned in your online trading, it’s wise to read a quality range of market analysis in order to learn how the experts interpret the data.