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Understanding Leading Economic Indicators
September 15, 2009

As part of a new feature, you can track and view leading indicators on the market and economy that we think matters to the investor. Click on the links within the article to get detailed explainations on why these indicators were used.


Author : iFAST Research Team



Untitled Document

Leading economic indicators give a picture of where the economy is headed in the next 6 to 9 months. Unlike market leading indicators, which can give a sense of where equity markets are heading, economic leading indicators give a sense of how the economy will perform.

First and foremost, we would like to identify three main types of indicators: leading indicators, coincident indicators and lagging indicators. There are uses for each. Respectively, they give us an idea on predicting when the economy will go through a downturn, reaffirming the economy’s growth or recession, and confirming that the economy is moving out of an expansionary or contractionary phase.

We focus on leading economic indicators because we believe that these indicators can give us an accurate picture of when the economy will start turning around. Equity markets typically start to recover even before the economy gets out of the doom and gloom of recession. That would mean that leading indicators could potentially give us an indication of a more sustainable recovery in equity markets.

We have selected quite a number of leading indicators for investors to track. But we think that the more common and easily understood ones would include:

  1. OECD India Composite Leading Indicator
  2. Money Supply (M2)
  3. Wholesale Price Index (WPI)
  4. Purchasing Manager Index (PMI)

OECD India Composite Leading Indicator

The OECD composite leading indicator (CLI) is designed to provide early signals of turning points (peaks and troughs) between expansions and slowdowns of economic activity The Indicators turn downwards a few months before the economy actually takes a downturn and turn upwards a few months before the economy actually becomes progressive.

 The component series used in the composite indicator compilation are:

  • Business confidence indicator (manufacturing)
  •  Monthly average exchange rate (INR/USD),
  •  Deposit interest rate of major banks (lower bound) (%),
  •  ITS Imports c.i.f. total (INR),
  • IIP basic goods
  • IIP intermediate goods
  • Monetary aggregate M1 (INR)
  • Composite stock price index (BSE Dollex)

Money Supply

The Money supply that we are looking at would be the M2 category of money supply. There are several categories of money supply and M2 is a broader classification of money than M1. It consists of Currency with the public + Deposit money of the public (Demand deposits with the banking system + ‘Other’ deposits with the RBI) and Savings deposits with Post office savings banks. Money supply tells economists and analysts how the current fiscal and monetary policy affects interest rates and growth. Growth in M2 means that there is a greater circulation of money in the market and economy. Under normal circumstances, rate of credit growth will increase as money in circulation increases. As credit growth improves, it could mean that business can make use of credit for business expansion. When M2 rises sharply and demand for money is stable, it signals rising inflationary pressures in the economy.

Wholesale Price Index

The Wholesale Price Index measures inflation. Very high values indicate high inflation. Any economy aims to have moderate inflation, and either low or high inflation prompts the Reserve Bank to take action. It would increase or decrease liquidity in the financial system by lowering or raising interest rates, which in turn affects the debt and lending markets. This affects the debt mutual funds and the economy as a whole.

Purchasing Manager Index

The Purchasing Manager Index (or PMI) is often used as a gauge of optimism or pessimism in the manufacturing industry. The numbers are usually arrived at through a series of questions regarding Business Activity, New Business, Employment, Input Prices, Prices Charged and Business Expectations. Typically, a score greater than 50 indicates an expansionary economy, while a score below 50 forecasts a sluggish economy for the next three to six months.

Conclusion

Using what we have compiled, we would like to help investors get a feel of the future direction of the economy. As always, information is power. Before the next recession or economic slowdown, tracking these forward-looking indices could be a better bet to understanding the intricacies of the relationships between individual economic indicators and the general economy itself.

     


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


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