‘Wouldn’t it be nice’ 

Wouldn’t it be nice to have one metric that we could all turn to in order to see how the economy is doing and whether we should invest more or hold off? (Before we dive deep into that thought, I will apologize in advance to anyone who now has the Beach Boys playing in your head for the rest of the day. Unfortunately, I am humming it as I type. I digress.) One metric, one indicator, one ring to rule them all! Well, maybe not the last one, but I would bet that most economists and consumers would appreciate one indicator that tells us what to do next.

As with all complex subjects, the probability of one measurement telling the whole story is quite rare. In medicine, we use a combination of results over a defined period to determine which medication to put the patient on. In finance or economics, we take a similar approach to many metrics that provide hindsight, insight, and foresight (to some extent) into the economy. These are referred to as lagging, coincident, and leading indicators (respectively). Each indicator provides puzzle pieces that start telling the story of the economy. These indicators are all linked to the business cycle, considering the cyclical nature of business with seasonal adjustments. Over the next three weeks, we’ll broadly describe each of these indicators and the metrics within each of the buckets. Let’s start with lagging indicators.

Keep in mind that the list of indicators may change in the future. Indicators have historically been replaced as the market changes to reflect appropriate reporting and needs.

Lagging Indicators

Lagging indicators, as inferred, consist of indicators that provide visibility of what has happened in the past, aggregated to give visibility on historical events that may indicate current or future events.

Yes, I know. Say it with me… “Past performance is not indicative of future results.” I agree. However, lagging indicators are very important when we trend the data and combine it with the other indicators to identify patterns. Let’s take a look at some lagging indicators and define them together.

• Average duration of unemployment

Unemployment is calculated as the average number of weeks that someone is out of work. The longer people are out of work, the greater the downstream impact on the economy. Decreases in unemployment rates generally occur after a recovery is already underway. When businesses have recovered or show signs of recovery, they are more willing to hire. On the other hand, unemployment rises after the economic downturn has already started.

• Ratio of manufacturing and trade inventories to sales

This metric calculates how many months, given the current pace of sales, it will take to liquidate inventories entirely.  Associate this metric with supply and demand dynamics and its impact on the economy. Demand for certain goods and services decreases if the economy isn’t doing well. This will directly affect the supply of these goods in the warehouses. An increase in this metric can reflect the decrease in demand for goods across the market. This metric can show what future production may be (based on inventory). However, the inventory rise occurs long after sales growth has halted. Thus, the appropriate categorization as a lagging indicator.

• Manufacturing labor cost per unit of output

This measure tracks productivity. If manufacturing costs increase and output decreases, this is a double whammy for businesses. Since monthly output and manufacturing costs can be volatile, this metric is reported as a percent change over six months. This indicator trend peaks during recessions.

• Average prime rate

As the economy expands or contracts, the Feds utilize monetary policy to ‘normalize’ these changes. The Fed fund rate has historically been the baseline for most financial institutions. Generally speaking, banks add 3% to the Feds fund rates to determine the prime rate. The average prime rate is the rate at which borrowers can lend money from banks or credit unions. Keep in mind that this rate is not for all borrowers. Depending on the borrower's creditworthiness, the rate may be adjusted with additional percentage points.

• Commercial and industrial loans outstanding

This metric looks into the total amount of industry loans outstanding. When diving into this metric, the belief is that as companies take out more loans, they invest back into the economy and focus on capital investments in their business. This indicator tends to peak when the economy is doing very well but hits lows a year after the end of a recession.

• Ratio of consumer installment credit to personal income

Consumers tend to reduce their personal borrowing during a recession or difficult financial times. Also, during this time, banks reduce lending due to non-payment risks. Thus, this metric highlights the pace at which credit utilization occurs in the market. This indicator bottoms out a year or more after a recession.

• Change in the consumer price index for services

You’re likely familiar with the Consumer Price Index (CPI). If not, quickly read Purchasing Power: the highs and lows. In contrast to CPI, this metric focuses only on services and service sector inflation. Service sector inflation tends to increase when an economy is already in a recession and decreases only after the recession has ended.

In the 1/3 end

Historically, we can’t say one indicator has been the driving force of the economy, but we can look at the trends and deduce some patterns of recognition that may provide guidance. Past performance never indicates future returns, but hopefully, you can see how the lagging indicators provide insight into the economy and trends. Lagging indicators show what has happened in the economy. These indicators show their full impact after recovery and, thus, are lagging.

Next week, we’ll explore coincident indicators, which focus on insight data and more near-real-time analytics.

As in any great trilogy, the first installment sets the stage and grabs your attention to want to read more. By this time, hopefully, the Beach Boys have exited stage left. Or now that I’ve mentioned it again, they’re returning for an encore. Whichever never-ending tune is stuck in your head, I hope you’ll join me in part 2 of this series next week. Of course, in the meantime, if you have any questions for our team at Whitaker-Myers Wealth Managers or one of our Financial Advisors, schedule some time with them to explore these topics and more.