When dealing with financial markets, traders and investors alike need to closely follow a wide range of data sources and indicators in order to stand a chance of making informed decisions that result in profits.
However, many beginner market participants often do not know where to start and what indicators to look for, what they mean and why they are so important.
Luckily, most economic indicators are less complex than they seem and understanding their impact on the market performance of financial instruments follows a relatively simple line of logic.
The most important economic indicators to consider
While many micro and macroeconomic data sources can be considered as economic indicators, not all of them are as influential and some only affect specific sectors of the economy and said effect is largely contained.
Therefore, it is important to look out for indicators that either affect a large portion of the economy, or could lead to a domino effect on other sectors of the economy as well.
Non-Farm Payrolls (NFP)
NFP meaning Non-Farm Payrolls, refers to the employment and job creation data, which shows how many new jobs have been created, the unemployment rate, and the overall strength of the labor market.
The United States Bureau of Labor Statistics issues NFP updates every month, which provides valuable insights into sector performance, wage growth, and other labor market factors.
For this reason, NFP is one of the most important indicators for long-term investors, as it greatly affects the capacity of the economy to increase output and productivity and grow in the long run.
Gross Domestic Product (GDP)
Gross Domestic Product, or GDP, is an economic indicator that measures the total value of all goods and services produced within a country’s borders, over a specific period of time – typically a fiscal year.
GDP serves as a key indicator of economic health, as the rate of GDP increase shows a booming economy, while a contraction may show a recession and greatly impact the confidence of local and international investors alike.
GDP figures of a particular economy are generally calculated using three approaches:
Production output, total earnings and total spending.
However, it is worth noting that GDP is far from a perfect indicator and does not account for wealth and income inequality, inflation and exchange rates and other nuances that provide a more detailed picture of how an economy is faring.
Consumer Price Index (CPI)
The Consumer Price Index measures the changes in the price levels of a basket of consumer goods and services. CPI is the baseline indicator for inflation used by economists and policymakers.
Inflation is an incredibly important indicator in and of itself, as it affects the purchasing power of consumers and can lead central banks to adjust interest rates to curb inflation and maintain economic stability.
When interest rates rise, this affects the bond market directly, as higher interest rates make bonds attractive investments due to a fixed income stream.
Therefore, when the CPI is high, this typically prompts interest rate hikes, which often diverts some of the capital from the stock market to the bond market, due to lower risks and higher coupon payments.
Purchasing Managers’ Index (PMI)
The Purchasing Managers’ Index, or PMI, is an indicator that measures the health of the manufacturing sector of the economy.
A PMI value of over 50 indicates expansion, while a PMI below 50 indicates contraction.
The PMI shows early signs of the sentiment among businesses, as well as potential changes in economic activity.
Strong PMI readings can often boost investor confidence and lead to a bullish trend on the stock market, as it shows a robust manufacturing sector, which also means the creation of more value-added products within the economy.
Retail Sales
Retail sales data reflects consumer preferences and buying power, as well as overall economic activity. When retail sales data is positive, this means that consumers have enough disposable income to spend while shopping.
Conversely, when retail sales are down, consumers might be saving up and preparing for a worsening economy, or might not be able to afford to spend as much on consumer goods, which is another negative indication for the health of an economy.
Conclusion
While there are multiple major economic indicators that are used by economists and policymakers alike, each sector of the economy also has smaller indicators that signal specific changes on the market, which may or may not spread to other areas of the economy if left unchecked. Therefore, long-term investors need to consider a range of different economic indicators and metrics in order to make their decisions with the sufficient amount of information at their disposal.
