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Smart Investor Tip of the Day
Predicting the direction of the economy is no more clearer to a pundit spending decades of his/her life in than it is to a new young investor entering the world of money management. But there are indicators that can help point one in a direction of what is likely to happen.
When attempting to predict the economy one must look to leading and lagging indicators. Leading indicators are future predictors and largely are affected by significant economic movements. Governments make use of them to help predict and prevent potential recessions. Lagging indicators reflect historic performances and are only identifiable after trends have occurred. So although it is not a predictor on where the economy is headed it is a good measure of long-term trends.
The stock market is one of the most popular leading indicators because underlying stock prices are based on what companies predict they will be earning, and so the economy’s direction is tied with earnings estimates.
Although the manufacturing sector continues to dwindle it is still a heavily scrutinized factor in determining the state of the economy. It affects the GDP deeply. So any increase in GDP reflects higher consumer demand for goods, which in turn represents a strong and growing economy.
Retail sales are also a good leading indicator because when sales rise companies tend to hire more employees to sell more goods which in turn floods more money into the hands of these employees who as consumers will tend to go spend it right away. However, the downside is that if those consumers buy on debt then if this gets out of control it could signal an impending recession on the horizon.
GDP, a lagging indicator, is the key measure of an economy’s state. If GDP rises then the economy is strong. Because GDP is a lagging indicator it doesn’t tell you what is going to happen, but what has happened; it is a good determinant if the country is entering a recession. If the GDP drops for more than two quarters then it is a strong indicator of an approaching recession.
If employers begin slashing wages and/or laying off workers it can indicate the economy is on a decline since a strong economy should reflect rising earnings to keep up with the average cost of living. When unemployment rates are high consumers have less money to spend which predictably contracts the retail sector, GDP, housing market, and stocks prices to list a few.
Ultimately the economy is directly linked to consumer activity and so when trying to understand the economy it is necessary to do personal research and not rely on TV figureheads for answers since they will have specific biased agendas that will cloud the truth of the economy.