Understanding Economic Indicators: A November Update

If you want to determine how the economy is doing, you must look beyond the current preoccupation with the unemployment rate to other indicators that are often overlooked.

Economists and market watchers follow economic indicators very closely. They look for signs that will tell them what to expect in the future.

Some market watchers follow indicators so they can determine how changes might affect investment portfolios, such as stocks, bonds and real estate investments.

Indicators are important to policy makers because they reveal signs regarding employment and unemployment – a key political issue, especially in an election year. Finally, business leaders follow indicators because they provide signals about the wisdom of making a capital investment or expanding into new markets.

All economic indicators are not equal; some are more important than others are. More importantly, the relevance of a particular indicator depends upon where the economy is situated in the business cycle. A business cycle is the regular pattern of ups and downs in the economy.

We typically call business cycles expansions and recessions. However, the business cycle has four phases: an expansion phase (sometimes called a recovery or growth stage); a peak; a contraction (usually called a recession); a trough (the bottom).

The phases of the business cycle resemble the up and down patterns of a wave. The positive incline of the wave represents the expansion. The top of the wave represents the peak. The downside of the wave represents the recession, and the bottom is the trough.

 Where is the US economy relative to the business cycle?

  • The housing bubble (expansion) lasted 120 months, from November 2001 (the trough) to December 2007 (the peak). Afterward, we entered the Great Recession.
  • The Great Recession lasted from December 2007 until June 2009, i.e. 18 months.
  • Since June of 2009, the US economy has been in the expansion or recovery phase. During the last 50 years, the typical expansion phase has lasted five years. Incidentally, we have had 11 business cycles since 1949.

During the expansion, some of the important indicators to watch are the following:

Initial claims for unemployment compensation: This provides a signal about whether firms are continuing to lay off workers or whether the labor market is improving. The most-recent  number (December 2012) was 370,000. The current level and trend are good indicators that the labor market has improved since the negative impact of Hurricane Sandy in November, when new claims spiked up to 404,000.

The change in payroll employment: This indicator comes from a broad national survey of business establishments, and it measures the number of new jobs firms added to their payrolls. In November the number was 146,000, which was twice the number predicted. While this is the most closely watched figure regarding the labor market, this number is also the most frequently adjusted one in subsequent months. For example, the original October number of 171,000 was adjusted downward to 138,000.

Personal Savings Rate: Before workers are paid, employers subtract taxes and other withholding from their paycheck. What remains is disposable income. The income is either spent, or if it is saved (investments are considered saving). Consumer purchases account for over two-thirds of all spending in the economy. Therefore, a small decrease in savings usually translates into a large increase in spending. When that occurs, the economy grows and businesses employ more workers. As of November 2012, consumers saved 3.4% of their disposable income. That is good because in the months following the Great Recession they were saving above 5%, which slowed down the rate of recovery. Consumers are now spending money, as reflected in the fact that Holiday sales thus far have increased by 5.8% and on-line sales by 12%.

Business Fixed Investment: This is a very important quarterly figure because it measures how much CEOs are willing to back up their plans with action. Fixed investment measures things like purchases of software and equipment and other forms of information technology, investments in new plants and machinery, etc. Last year, corporations were hoarding cash because they were so uncertain about the future. Currently, business investment is dead in the water (-2.2%) because CEOs are waiting to see what will happen with negotiations regarding the fiscal cliff. In the second quarter of 2012, corporations had more confidence and invested more, 3.6%; however, not as much as they did in the 1st quarter of 2012, 7.5%. Investment will remain flat until budget negotiations are worked out.

Change in the Civilian Labor Force: The monthly change in the size of the labor force is one of the most important and most overlooked indicators of the health of the economy. The unemployment rate can fall because unemployed workers get discouraged and drop out of the labor force. Dropouts are not counted among the unemployed. When this happens, the unemployment rate can decline, giving a false sense of security. The best signal of a healthy economy is when the labor force is increasing (because discouraged workers are coming back), and the unemployment rate is decreasing at the same time. This happened in September, 2012 when the unemployment rate declined from its 8.1% to 7.8%, and labor force expanded by 418,000 workers, the total number of employed workers increased by 873,000 and the number of unemployed workers decreased by 456,000 workers. In November, 2012, unemployment dropped to 7.7%, but also the size of the labor force declined by 350,000; surprisingly, 306,000 of the decline (87%) was due to Black workers. That is why in November, Black unemployment declined to 13.2% from 14.3% in October.