A leading indicator is a measurable set of data that may help to forecast future economic activity. Leading economic indicators can be used to predict changes in the economy before the economy begins to shift in a particular direction. They are invaluable for businesses, investors, and policymakers.
Leading indicators are one of three primary types of indicators, with the other two being lagging indicators and coincident indicators.
Key Takeaways
- A leading indicator is economic data that may correspond with a future movement or change in the economy.
- Leading economic indicators can help predict an occurrence or forecast the timing of events and trends in business, markets, and the economy.
- Different leading indicators vary in their accuracy and leading relationships, so it is wise to consult a range of leading indicators when planning for the future.
- Leading indicator examples include the Consumer Confidence Index, Purchasing Managers’ Index, initial jobless claims, and average hours worked.
- Lagging indicators are metrics that confirm change rather than predict it.
Understanding Leading Indicators
Leading indicators must be measurable to be useful as predictors of where the economy may be headed. Policymakers and central bankers use leading indicators when setting fiscal or monetary policy. Businesses analyze them to anticipate future economic conditions, making strategic market and revenue decisions.
Businesses often track their own bottom lines and balance sheets, which are lagging indicators. Importantly, a business’s past performance does not necessarily indicate future results.
Investors use leading indicators to guide their investment strategies, anticipating market conditions. Many focus on indicators closely related to the stock market – housing market, retail sales, building permits, business startups, and more.
Examples of Leading Indicators
Purchasing Managers’ Index
Economists closely watch the Purchasing Managers’ Index (PMI). The PMI reflects trends in the manufacturing and service sectors and acts as a useful signal of growth in a nation’s gross domestic product (GDP) due to changes in material demand from corporations.
Durable Goods Orders
Durable goods orders, a monthly survey produced by the U.S. Census Bureau, measure industrial activity in the durable goods sector and the state of the supply chain.
Consumer Confidence Index
The Consumer Confidence Index (CCI) is considered one of the most accurate leading indicators. It surveys consumers about their attitudes toward the economy and their perceptions of future economic activity.
Jobless Claims
The U.S. Department of Labor provides a weekly report on the number of jobless claims, indicating the economy’s health. A rise in jobless claims signals a weakening economy, whereas a drop may suggest that companies are growing, potentially boosting the stock market.
Yield Curve
The yield curve is a heavily watched indicator, especially the spread between two-year and 10-year Treasury yields. An inverted yield curve, where two-year yields exceed 10-year yields, may signal an approaching recession.
Company Performance
Customer complaints or negative online reviews can serve as leading indicators of customer dissatisfaction, signaling potential problems with product quality or service failures. Conversely, positive customer feedback suggests favorable future revenue, growth, or profits.
Accuracy of Leading Indicators and How to Use Them
Conflicting Signals
Leading indicators are not always accurate. However, examining multiple leading indicators alongside other data can provide actionable insights about an economy’s future health.
An ideal leading indicator would predict changes in economic trends or business performance accurately, within a narrow range of estimates, and over a substantial time horizon. In practice, performance along these lines varies.
For instance, capital goods new orders can offer a long lead time for action but may provide low precision on when to take it. Moreover, this indicator’s magnitude might not consistently relate to GDP changes, making it useful longer-term but not for precise estimates.
Conversely, an indicator might give highly accurate, precise information about market or economic turning points, but only over a short duration. Hence, optimizing business or investment trends may require diverse leading indicators, balancing accuracy, precision, and foresight.
Leading Indicators vs. Lagging Indicators
Leading indicators predict future economic performance, whereas lagging indicators reflect past performance, confirming economic changes and financial market patterns.
Leading Indicators
- Measurable Data: Indicates potential upcoming economic changes.
- Predictive Power: Alerts users to specific economic changes/trends.
- Usage: By economists, analysts, businesses, and investors to take preemptive actions.
- Accuracy: Not foolproof, but improved with consideration of other economic data.
- Data Range: Covers diverse economic activities.
Lagging Indicators
- Measured Effects: Reflect the aftermath of economic activity.
- Validation: Confirms trends, performance quality, and business decision impacts.
- Usage: By governments, businesses, and investors to strategize based on proven assumptions.
- Reliability: Based on past economic activities’ outcomes.
- Data Range: Focuses on historical financial results.
Frequently Asked Questions
What Are Leading and Lagging Indicators?
Leading indicators predict economic, business, or investment trends, while lagging indicators change after an economic or business trend occurs, reflecting its effects.
What Are the 3 Types of Economic Indicators?
The three main economic indicators are leading indicators (predict trends), lagging indicators (reflect past activity), and coincident indicators (reflect current activity).
Where Can I Find Reports on Leading Indicators?
Reports are issued by various government agencies and other organizations. Key entities include The Conference Board (Consumer Confidence Index), the U.S. Department of Labor (jobless claims), and the U.S. Census Bureau (durable goods orders).
What Is an Example of a Leading Indicator?
A notable example of a leading indicator is the Consumer Confidence Index (CCI), measuring consumers’ optimism or pessimism regarding their expected financial future.
The Bottom Line
Leading indicators can be invaluable tools for economists, investors, business owners, and consumers. When properly used, they can signal upcoming changes and broad economic trends. However, relying solely on leading indicators is risky. A balanced approach that considers which indicators are most relevant and how to interpret them correctly is crucial.
Related Terms: lagging indicators, coincident indicators, economic activity, business strategy, investment planning.
References
- Federal Reserve Bank of Chicago. “Which Leading Indicators Have Done Better at Signaling Past Recessions?”
- Moody’s Analytics. “United States—Purchasing Managers Index”.
- U.S. Census Bureau. “Why New Data on Durable Goods Matter”.
- The Conference Board. “U.S. Consumer Confidence”.
- U.S. Bureau of Labor Statistics. “How the Government Measures Unemployment”.
- Forex.com. “Treasury Yields Explained: What Does the Yield Curve Tell Us?”
