As an investor, you should be following the United States and world economic activity. You will find that the overall economy has a direct impact on your portfolio and that by gaining an understanding of how the economy relates to the financial markets and your portfolio, you will be able to substantially increase your returns.
Online Resources: Economics News and Data
· Bureau of Economic Analysis: http://www.bea.doc.gov/
· US Census Bureau: http://www.census.gov/
· US Department of Commerce: http://www.commerce.gov/
· Federal Reserve: http://www.federalreserve.gov/
· St. Louis Federal Reserve Bank: http://www.stls.frb.org/
· Federal Reserve Bank of Philadepphia: http://www.phil.frb.org/
· Business Cycle Indicators: http://www.globalindicators.org/
Below, we discuss some key concepts to get you started.
The gross domestic product (GDP) is the broadest measure of the economy’s performance. It is the Commerce Department’s estimate of the total dollar value of all goods and services produced in this country. What’s important about the GDP is not the number itself, but the change from one quarter to the next. This tells the rate at which the US economy is growing.
As we will discuss later, the largest portion of GDP is consumer income and spending while the portion of GDP that fluctuates the most, and therefore has the largest impact on GDP growth, is corporate earnings and expenditures.
The main interest rate to watch is the 10-year Treasury rate. The reason this particular interest rate is important is that it is set by the marketplace, as opposed to the federal funds rate, which the government establishes.
The market for 10-year Treasuries is anticipatory, meaning it reflects changes before they occur. Therefore, changes in the 10-year Treasury rate reflect the market’s overall economic outlook. A rise in the interest rate on 10-year Treasuries causes bond prices to fall. As we discuss earlier in this Chapter in our detailed description of bond markets, as interest rates on current bonds increase, the demand for outstanding bonds decline since investors can purchase new-issues that yield a higher interest rate. Therefore, for bond yields between new-issues and outstanding bonds to be comparable, the price of outstanding bonds decline (typically to a discount to the bond’s par value).
Interest rate increases also has an effect on the stock market. There are two theories as to the impact of interest rates on the stock market:
Declining interest rates is often seen as a positive sign for the stock market. Declines in interest rates are often followed by increases in the price of stocks.
A commonly followed measure of inflation is the consumer price index (CPI). The rate of change in the CPI is commonly followed and is stated as a percentage. The inflation rate directly affects interest rates and economic growth, so it is watched very closely.
The accepted policy of the Federal Reserve Board (The Fed), has been to regulate the economy in terms of balancing economic growth relative to the rate of inflation. The Fed views a direct relationship between interest rates and inflation. Low interest rates leads to a high rate of growth in the economy. If economic growth is accompanied by demand for US goods and services exceeding supply, prices are driven higher – leading to excessive inflation. Therefore, it is Fed policy to watch inflation very closely and adjust interest rates accordingly.
Another closely-watched statistic is the unemployment rate. During times of economic expansion, a low unemployment rate leads to increased purchases on consumer goods, often leading to inflation. On the other hand, at the end of a recession, the final sign of an economic recovery is often a decline in the unemployment rate. It is not until large corporations are on solid footing that they begin to re-hire on a larger scale.
The Business Cycle Indicators are a good source where the above statistics combined with many more come together. The Business Cycle Indicators are comprised of the Leading, Coincident, and Lagging Economic Indicators and are produced monthly by The Conference Board. These indicators are used to gauge the performance of the overall US macro-economy. These indices are released monthly by The Conference Board on their website http://www.globalindicators.org and as described in Chapter 4, are often used by investors to help make investment decisions.
These indices are designed to measure the peaks and troughs in the business cycle. The leading, coincident, and lagging indexes are essentially composite averages of between four and ten individual leading, coincident, or lagging indicators. They are constructed to clearly summarize and reveal common turning point patterns in the overall US economy.
Historically, the cyclical turning points in the leading index have occurred before those in aggregate economic activity, while the cyclical turning points in the coincident index have occurred at about the same time as those in aggregate economic activity. The cyclical turning points in the lagging index generally have occurred after those in aggregate economic activity. The leading index is closely followed by the financial markets.