State of the Market

Many factors move the markets, but perhaps no factor has more of an impact than the state the economy. The direction of the economy can dramatically affect the earnings growth of entire industries, let alone individual companies. What are some of the more important indicators to monitor?

Inflation: Late in an economic recovery, inflation (the increase in the cost of living) has a major impact on the market. If inflation rises faster than expected, interest rates rise and borrowing costs increase, a negative for stocks. If inflation declines, rates and borrowing costs fall, a good sign for stocks.

Track the inflation rate monthly by following the Consumer Price Index (CPI). Released by the Bureau of Labor Statistics, the CPI is reported in the newspapers and on television. It measures price changes for a basket of goods and services, which includes food, housing, and transportation.

Initial Unemployment Claims: Released monthly by the Bureau of Labor Statistics, this report provides a snapshot of the prevailing employment picture. When the number of claims comes in higher than analysts expect, it means the economy is slowing, which is good for stocks because it means inflation is under control. When the number is lower than anticipated, it means more people are working and pouring money into the economy, which could raise inflation, a bad sign for stocks.

Index of Leading Economic Indicators (LEI): The LEI reflects the economy's health. It tends to forewarn of business downturns six to nine months before they occur. The LEI consists of 11 economic indicators, such as unfilled durable-goods orders, average manufacturing work week, plant and equipment orders, sensitive material prices, vendor performance, and new orders for consumer goods. Generally, three consecutive monthly LEI changes in the same direction signal a shift in the direction of the economy. If it increases in three straight months, it means the economy is likely to grow, which could be viewed favorably by investors if the growth is considered moderate. Declines in three straight months suggest that the economy could be headed for recession, a negative for stocks. (Slow growth is good for equities in a mature economic environment, but when growth is too slow, the thinking is that earnings cannot support higher stock prices.)

These are just a few of the economic indicators to follow. There are many others that should be considered to make a prudent decision about the market's direction. Talk with your financial consultant for help in tracking the economy and the markets.

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