Leaders and Laggards

By Egan on October 8, 2019

What trends and data can tell you about the state of the economy

It seems like everybody has an opinion these days on the current state of the U.S. economy. The Fed has cut the fed funds rate by 50 basis points since July. Major stock market indices erase months of gains then hit new highs, all within a few days. Jobs and inflation numbers surprise then disappoint. What is an investor to make of all this noise? Historically, there are several key indicators that start blinking when the tide changes. We’ve outlined several of them below. History doesn’t always repeat itself perfectly. However, we do believe it often rhymes.

Leaders

Some data points provide advance warning that the direction of the economy may change. These are called “leading indicators,” and many of them capture changes in activities that determine the growth rate of the economy. One such indicator is the Purchasing Managers Index (PMI) reading, furnished by the Institute of Supply Management. The PMI reading looks at whether or not the manufacturing and service sectors are expanding, contracting, or remaining stable. Generally, a reading above 50 means expansion. Manufacturers will produce more goods if orders increase, indicating a possible uptick in demand. Next, retail sales are a helpful indicator of economic growth. The U.S. Gross Domestic Product (GDP), which is a prominent measure of economic output, is mostly powered by the consumer. If people buy things, they generate demand and stoke the economy. Retail sales figures capture a piece of this demand. Building permits are also a helpful leading indicator. If people or companies apply for building permits, it likely means impending construction. Construction activity means jobs and orders for building materials, and more spending.

Laggards

As previously mentioned, GDP is a heavily cited measure of economic health. It is a lagging indicator. It is often measured on a quarterly basis and is simply a snapshot of what has already happened. The reading can also be heavily influenced by outlying factors, like government stimulus or adverse weather conditions. Employee wages and the unemployment rate are also lagging indicators. When the economy is healthy, wages generally rise at a rate in line with inflation. If the job market is particularly tight, which can occur in the later stages of an economic cycle, wages might rise more quickly as companies compete for talent. Unemployment rates drop as jobs are filled by those who were previously not working, but actively seeking work. An unemployment figure between 3%-5% is generally considered normal. Inflation, measured by the Consumer Price Index (CPI), is also a lagging indicator. A small amount of inflation can be healthy for an economy, as it indicates consumers are purchasing goods and driving prices moderately higher. Currently, the U.S. Federal Reserve targets a 2% inflation rate.

Growth vs Value

A rotation typically takes place towards the end of an economic cycle. As the growth rate of corporate profits begins to slow, investors will often shift their attention to more defensive, dividend paying, value-oriented holdings. Defensive sectors are considered to be things that consumers will continue to purchase regardless of the current state of the economy. These items include health care, utilities, rental housing, and consumer staples. At times, stocks within these more defensive areas will begin to outperform growth-oriented sectors such as technology and consumer discretionary when the economy starts to decelerate and consumer and business spending slows.

At The Egan Group, we’re here to discuss your questions regarding the economy, your investment strategy, and how the two may interact. Periods of volatility and uncertainty are common, and we’d like to remind our clients that when constructing your portfolio and projected long-term rate of return, we’ve already baked in the fact that market hiccups will occur. No progress, economic or otherwise, is constantly forward moving, and that’s ok. We’re here for you in up markets, down markets, and everything in between. If you haven’t visited us in a while to review your goals and discuss your portfolio, w