Fundamental Analysis

Introduction

Fundamental Analysis is the study of any data that might be expected to impact the price or perceived value of an investment product, other than analyzing the trading patterns of that stock itself.

Fundamental analysis is the examination of the underlying forces that affect the well being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements.

At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition.

At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. By believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies.

Interest rates for example, are considered the single most important economic factor determining the exchange rates of currencies. One reason for this is that large multinational investors would prefer to hold a bank account in the currency that yields the highest return in terms of interest, all other things being equal. Inflation is one of the key factors in deciding the level of interest rates. For this reason any financial data released that will affect interest rates or inflation is of great importance to a trader, as it will offer trading opportunities as the market re-values itself.

Jobless Claims

Definition

A weekly compilation of the number of individuals who filed for unemployment insurance for the first time. This indicator, and more importantly, its four-week moving average, portends trends in the labour market.

Why do Investors Care?

Jobless claims are an easy way to gauge the strength of the job market. The fewer people filing for unemployment benefits, the more have jobs, and that tells investors a great deal about the economy. Nearly every job comes with an income that gives a household spending power. Spending greases the wheels of the economy and keeps it growing, so a stronger job market generates a healthier economy.

There's a downside to it, though. Unemployment claims, and therefore the number of job seekers, can fall to such a low level that businesses have a tough time finding new workers. They might have to pay overtime wages to current staff, use higher wages to lure people from other jobs, and in general spend more on labour costs because of a shortage of workers. This leads to wage inflation, which is bad news for the stock and bond markets. Federal Reserve officials are always on the look out for inflationary pressures.

By tracking the number of jobless claims, investors can gain a sense of how tight, or how loose, the job market is. If wage inflation threatens, it's a good bet that interest rates will rise, bond and stock prices will fall, and the only investors in a good mood will be the ones who tracked jobless claims and adjusted their portfolios to anticipate these events.

Just remember, the lower the number of unemployment claims, the stronger the job market, and vice versa.

Effects of U.S Economic Indictors

Big Reaction / Average Reaction / Small Reaction / No Reaction

Economic Data Up/Down Dollar Stocks Bond
Interest Rates Average Reaction Big Reaction Big Reaction Big Reaction
Money Supply Average Reaction Big Reaction Big Reaction Big Reaction
Unemployment Average Reaction Big Reaction Big Reaction Big Reaction
Non-farm Payrolls Average Reaction Big Reaction Big Reaction Big Reaction
Gross National Product Average Reaction Big Reaction Big Reaction Average Reaction
Consumer Price Index Average Reaction Average Reaction Average Reaction Average Reaction
Producer Price Index Average Reaction Average Reaction Average Reaction Average Reaction
Trade Balance Average Reaction Big Reaction Average Reaction Average Reaction
Leading Econ. Indicators Average Reaction Big Reaction Big Reaction Average Reaction
Jobless Claims Average Reaction Average Reaction Average Reaction Average Reaction
Industrial Production Average Reaction Average Reaction Average Reaction Average Reaction
Capacity Utilisation Average Reaction Average Reaction Average Reaction Average Reaction
ISM Average Reaction Average Reaction Average Reaction Average Reaction
Personal Income Average Reaction Average Reaction Average Reaction Average Reaction
Car Sales Average Reaction Average Reaction Average Reaction Average Reaction
Retail Sales Average Reaction Average Reaction Big Reaction Average Reaction
Durable Goods Average Reaction Average Reaction Big Reaction Average Reaction
Consumer Confidence Average Reaction Average Reaction Average Reaction Average Reaction
Housing Starts Average Reaction Average Reaction Average Reaction Average Reaction
New Home Sales Average Reaction Average Reaction No Reaction Average Reaction
Construction Spending Average Reaction Average Reaction No Reaction No Reaction
Factory Orders Average Reaction Average Reaction No Reaction Average Reaction
Business Inventories Average Reaction Average Reaction No Reaction No Reaction

Durable Goods Orders

Definition

Durable goods orders reflect the new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods.

Importance

Durable goods orders are a leading indicator of industrial production and capital spending.

Why do Investors Care?

Investors want to keep their finger on the pulse of the economy because it usually dictates how various types of investments will perform. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market doesn't mind growth but is extremely sensitive to whether the economy is growing too quickly and paving the road for inflation. By tracking economic data like durable goods orders, investors will know what the economic backdrop is for these markets and their portfolios.

Orders for durable goods show how busy factories will be in the months to come, as manufacturers work to fill those orders. The data not only provide insight to demand for things like refrigerators and cars, but also business investment going forward. If companies commit to spending more on equipment and other capital, they are obviously experiencing sustainable growth in their business. Increased expenditures on investment goods sets the stage for greater productive capacity in the country and reduces the prospects for inflation. That tells investors what to expect from the manufacturing sector, a major component of the economy and therefore a major influence on their investments.

Interpretation

The bond market will rally (fall) when durable goods orders are weak (strong). A moderately healthy report for new orders bodes well for corporate profits and the stock market, however. Durable goods orders are one of the most volatile economic indicators reported in the month and also revised by significant amounts. More than any other indicator, it is imperative to follow either three-month moving averages of the monthly levels or year-over-year percent changes. These adjustments smooth out the monthly variability and provide a clearer picture of the trend in the manufacturing sector.

Frequency

Monthly

Source

Bureau of the Census, U.S. Department of Commerce.

Availability

Usually during the fourth week of the month.

Coverage

Data are for the previous month. Data released in June are for May.

Revisions

Monthly, data for the prior two months are revised to reflect more complete information. Annually, new seasonal adjustment factors are introduced. This revision affects at least three years of data. The magnitude of the revision can be substantial.

Employment Data

Definition

The employment situation is a set of labour market indicators. The unemployment rate measures the number of unemployed as a percentage of the labour force. Nonfarm payroll employment counts the number of paid employees working part-time or full-time in the nation's business and government establishments. The average workweek reflects the number of hours worked in the non farm sector. Average hourly earnings reveal the basic hourly rate for major industries as indicated in non farm payrolls.

Importance

The Employment Situation is the primary monthly indicator of aggregate economic activity because it encompasses every major sector of the economy. It is comprehensive and available early in the month. Many other economic indicators are dependent upon its information. It not only reveals information about the labour market, but about income and production as well. In short, it provides clues about other economic indicators reported for the month and plays a big role in influencing financial market psychology during the month.

Why do Investors Care?

If ever there was an economic report that can move the markets, this is it! The anticipation on Wall Street each month is palpable, the reactions are dramatic, and the information for investors is invaluable. By digging just a little deeper than the headline unemployment rate, investors can take more strategic control of their portfolio and even take advantage of unique investment opportunities that often arise in the days surrounding this report.

The employment data give the most comprehensive report on how many people are looking for jobs, how many have them, what they're getting paid and how many hours they are working. These numbers are the best way to gauge the current state as well as the future direction of the economy.

The employment statistics also provide insight on wage trends, and wage inflation is high on the list of enemies for the Federal Reserve. Fed chairman Ben Bernanke talks about this data frequently and watches for inflation constantly, even when economic conditions are soggy. If inflation is under control, it is easier for the Fed to maintain a more accommodative monetary policy. If inflation is a problem, the Fed is limited in providing economic stimulus.

By tracking the jobs data, investors can sense the degree of tightness in the job market. If wage inflation threatens, it's a good bet that interest rates will rise; bond and stock prices will fall. No doubt that the only investors in a good mood will be the ones who watched the employment report and adjusted their portfolios to anticipate these events. In contrast, when job growth is slow or negative, then interest rates are likely to decline - boosting up bond and stock prices in the process.

Interpretation

The bond market will rally (fall) when the employment situation shows weakness (strength). The equity market often rallies with the bond market on weak data because low interest rates are good for stocks. But sometimes the two markets move in opposite directions. After all, a healthy labour market should be favourable for the stock market because it supports economic growth and corporate profits. At the same time, bond traders are more concerned about the potential for inflationary pressures.

The unemployment rate rises during cyclical downturns and falls during periods of rapid economic growth. A rising unemployment rate is associated with a weak or contracting economy and declining interest rates. Conversely, a decreasing unemployment rate is associated with an expanding economy and potentially rising interest rates. The fear is that wages will accelerate if the unemployment rate becomes too low and workers are hard to find.

Frequency

Monthly

Source

Bureau of Labour Statistics, U.S. Department of Labour

Availability

Usually the first Friday day of the month.

Coverage

Data are for the previous month.

Revisions

Monthly, data for the two prior months are revised to incorporate more complete information. The revisions affect five years of data. The magnitude of revisions is usually moderate, but sometimes substantial.

Gross Domestic Product

Definition

Gross Domestic Product (GDP) is the broadest measure of aggregate economic activity and encompasses every sector of the economy. It represents the total value of the country's production during the period and consists of the purchases of domestically produced goods and services by individuals, businesses, foreigners and government entities.

Importance

Gross Domestic Product is the country's most comprehensive economic scorecard.

Why do Investors Care?

GDP is the consummate measure of economic activity. Investors need to closely track the economy because it usually dictates how investments will perform. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market doesn't mind growth but is extremely sensitive to whether the economy is growing too quickly and paving the road to inflation. By tracking economic data like GDP, investors will know what the economic backdrop is for these markets and their portfolios.

The GDP report contains a treasure-trove of information, which not only paints an image of the overall economy, but also tells investors about important trends within the big picture. GDP components like consumer spending, business and residential investment, and price (inflation) indexes illuminate the economy's undercurrents, which can translate to investment opportunities and guidance in managing a portfolio.

Interpretation

When gross domestic product expands more (less) rapidly that its potential, bond prices fall (rise). Healthy GDP growth usually translates into strong corporate earnings that bode well for the stock market.

Net exports are a drag on total GDP because the United States regularly imports more than it exports, that is, net exports are in deficit. When the net export deficit becomes less negative, it adds to growth because a smaller amount is subtracted from GDP. When the deficit widens, it subtracts even more from GDP.

Frequency

Quarterly

Source

Bureau of Economic Analysis, U.S. Department of Commerce

Availability

Usually during the fourth week of the month.

Coverage

Data are for the prior quarter. Data released in April are for the first quarter.

Revisions

Monthly, revised estimates are released based on more complete information during the second and third months of the quarter. This revision affects at least three years of data. The magnitude of the revision is generally moderate.

Housing Starts

Definition

Housing starts measure the number of residential units on which construction is begun each month.

Importance

Housing starts reflect the commitment of builders to new construction activity. Purchases of household furnishings and appliances quickly follow.

Why do Investors Care?

Two words...Ripple Effect. This narrow piece of data has a powerful multiplier effect through the economy, and therefore across the markets and your investments. By tracking economic data such as housing starts, investors can gain specific investment ideas as well as broad guidance for managing a portfolio.

Homebuilders don't start a house unless they are fairly confident it will sell upon or before its completion. Changes in the rate of housing starts tell us a lot about demand for homes and the outlook for the construction industry. Furthermore, each time a new home is started, construction employment rises, and income will be pumped back into the economy. Once the home is sold, it generates revenues for the homebuilder and a myriad of consumption opportunities for the buyer. Refrigerators, washers and dryers, furniture, and landscaping are just a few things new home buyers might spend money on, so the economic "ripple effect" can be substantial especially when you think of it in terms of a hundred thousand new households around the country doing this every month.

Since the economic backdrop is the most pervasive influence on financial markets, housing starts have a direct bearing on stocks, bonds and commodities. In a more specific sense, trends in the housing starts data carry valuable clues for the stocks of homebuilders, mortgage lenders, and home furnishings companies. Commodity prices such as lumber are also very sensitive to housing industry trends.

Interpretation

The bond market will rally when housing starts decrease, but bond prices will fall when housing starts post healthy gains. A strong housing market is bullish for the stock market because the ripple effect of housing to consumer durable purchases spurs corporate profits. In turn, low interest rates encourage housing construction.

The level as well as changes in housing starts reveal residential construction trends. Housing starts are subject to substantial monthly volatility, especially during winter months. Following either the three-month moving averages of the monthly levels or year-over-year percent changes will smooth out monthly volatility and provide a more accurate picture of the underlying trend.

Frequency

Monthly

Source

Bureau of the Census, U.S. Department of Commerce

Availability

Usually during the third week of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, data for the prior two months are revised to incorporate more complete information. These revisions affect at least three years of data. The magnitude of the revisions is typically small.

FOMC Meeting

Definition

The Federal Open Market Committee consists of the seven Governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year in order to determine the near-term direction of monetary policy. Changes in monetary policy are now announced immediately after FOMC meetings.

Why do Investors Care?

The Fed determines interest rate policy at FOMC meetings. These occur roughly every six weeks and are the single most influential event for the markets. For weeks in advance, market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching. The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates. A change in the fed funds rate, the lending rate banks charge each other for the use of overnight funds, translates directly through to all other interest rates from Treasury bonds to mortgage loans. It also changes the dynamics of competition for investor dollars: when bonds yield 10 percent, they will attract more money away from stocks then when they only yield 5 percent. The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.

ISM Manufacturing Index

Definition

The Institute for Supply Management, formerly known as the National Association of Purchasing Management, compiles an index of national manufacturing conditions. Readings above 50% for the ISM manufacturing index indicate an expanding factory sector.

Importance

The ISM manufacturing composite index indicates overall factory sector trends. The relevance of this indicator is enhanced by the fact that it is available very early in the month and not subject to revision.

Why do Investors Care?

Investors need to keep their fingers on the pulse of the economy because it dictates how various types of investments will perform. By tracking economic data like the ISM manufacturing index, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers less rapid growth and is extremely sensitive to whether the economy is growing too quickly and causing potential inflationary pressures.

The ISM manufacturing data gives a detailed look at the manufacturing sector, how busy it is and where things are headed. Since the manufacturing sector is a major source of cyclical variability in the economy, this report has a big influence on the markets. More than one of the ISM sub-indexes provides insight on commodity prices and clues regarding the potential for developing inflation. The Federal Reserve keeps a close watch on this report that helps it to determine the direction of interest rates when inflation signals are flashing in these data. As a result, the markets are highly sensitive to this report.

Interpretation

The bond market will rally (fall) when the ISM manufacturing index is weaker (stronger) than expected. Equity markets prefer lower interest rates and could rally with the bond market. However, a healthy manufacturing sector, indicated by rising ISM index levels, bodes well for corporate earnings and is bullish for the stock market.

The level of the ISM manufacturing composite index suggests the momentum in manufacturing. Historically, readings of 50% or above are associated with an expanding manufacturing sector and a healthy economy. Readings of 42.7% or above represent a contracting manufacturing sector and a stagnant, albeit modestly growing economy. Readings below 42.7% are typically associated with contraction in both the manufacturing sector and overall activity.

Frequency

Monthly

Source

National Association of Purchasing Management

Availability

Usually the first business day of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, none. Annually, new seasonal adjustment factors are introduced. The magnitude of the revision is typically minor.

Personal Income And Outlays

Definition

Personal income is the dollar value of income received from all sources by individuals. Personal outlays include consumer purchases of durable and nondurable goods, and services.

Importance

Income is the major determinant of spending-U.S. consumers spend roughly 95 cents of each new dollar. Consumer spending accounts directly for nearly two-thirds of overall economic activity and indirectly influences capital spending, inventory investment and imports.

Why do Investors Care?

The income and outlays data are another handy way to gauge the strength of the economy and where it is headed. Income gives households the power to spend and/or save. Spending greases the wheels of the economy and keeps it growing. Savings are often invested in the financial markets and can drive up the prices of stocks and bonds. Even if savings simply go into a bank account, part of those funds are typically used by the bank for lending and therefore contribute to economic activity. The only way savings fail to contribute is if they are deposited under the mattress, and not too many people do that anymore.

The consumption (outlays) part of this report is even more directly tied to the economy, which we know usually dictates how the markets perform. Consumer spending accounts for two-thirds of the economy, so if you know what consumers are up to, you'll have a pretty good handle on where the economy is headed. Needless to say, that's a big advantage for investors.

Interpretation

Increases (decreases) in income and consumption cause bond prices to fall (rally). As long as spending isn't inflationary, the stock market benefits because greater spending spurs corporate profits. It is worth noting that financial market participants pay somewhat less attention to this report than to retail sales which are released earlier in the month.

Changes in personal income signal changes in consumer spending. Comparing these changes indicates whether households are "overspending" and will need to slow their pace of expenditures or "under spending" and have the potential to accelerate their rate of purchases.

Frequency

Monthly

Source

Bureau of Economic Analysis, U.S. Department of Commerce

Availability

Usually the last week of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, data for the prior three months are revised to incorporate more complete information. These revisions affect at least five years of data. The magnitude of the revisions is typically small.

Producer Price Index

Definition

The Producer Price Index (PPI) is a measure of the average price level for a fixed basket of capital and consumer goods paid by producers.

Importance

The producer price index for finished goods is a major indicator of commodity prices in the manufacturing sector. These prices are more sensitive to supply and demand pressures than the more comprehensive consumer price index. Producer price changes are considered a leading indicator for consumer price changes.

Why do Investors Care?

The PPI measures price changes in the manufacturing sector. Inflation at this producer level often gets passed through to the consumer price index (CPI). By tracking price pressures in the pipeline, investors can anticipate inflationary consequences in coming months. Investors need to monitor inflation closely. Just knowing what inflation is and how it influences the markets can put an individual investor head and shoulders above the crowd. (See CPI notes) By tracking the trends in inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform.

Interpretation

The bond market will rally when the PPI decreases or posts only small increases, but bond prices will fall when the PPI post larger-than-expected gains. The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.

Frequency

Monthly

Source

Bureau of Labour Statistics, U.S. Department of Labour

Availability

Usually the second week of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, data for the third month previous are revised based on more complete information. This revision affects the last five years of data. The magnitude of revisions is small.

Retail Sales

Definition

Retail sales measure the total receipts at stores that sell durable and nondurable goods.

Importance

Retail sales are a major indicator of consumer spending trends because they account for nearly one-half of total consumer spending and approximately one-third of aggregate economic activity.

Why do Investors Care?

Consumer spending accounts for two-thirds of the economy, so if you know what consumers are up to, you'll have a pretty good handle on where the economy is headed. Needless to say, that's a big advantage for investors.

The pattern in consumer spending is often the foremost influence on stock and bond markets. For stocks, strong economic growth translates to healthy corporate profits and higher stock prices. For bonds, the focus is whether economic growth goes overboard and leads to inflation. Ideally, the economy walks that fine line between strong growth and excessive (inflationary) growth. This balance was achieved through much of the nineties. For this reason alone, investors in the stock and bond markets enjoyed huge gains during the bull market of the 1990s. Retail sales growth did slow down in tandem with the equity market in 2000 and 2001.

Retail sales not only give you a sense of the big picture, but also the trends among different types of retailers. Perhaps auto sales are especially strong or apparel sales are showing exceptional weakness. These trends from the retail sales data can help you spot specific investment opportunities, without having to wait for a company's quarterly or annual report.

Interpretation

Strong retail sales are bearish for the bond market, but favourable for the stock market, particularly retail stocks. Sluggish retail sales could lead to a bond market rally, but will probably be bearish for the stock market.

Frequency

Monthly

Source

Bureau of the Census, U.S. Department of Commerce

Availability

Usually the second or third week of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, data for the two prior months are revised to incorporate more complete information. This revision affects at least three years of data. The magnitude of the revisions is usually moderate.

Beige Book

Definition

A compilation of economic conditions from each of the 12 Federal Reserve regional districts. Data are anecdotal and qualitative, rather than quantitative, in nature. This book is produced before the monetary policy meetings of the Federal Open Market Committee.

Why do Investors Care?

This report on economic conditions is used at FOMC meetings, where the Fed sets interest rate policy. These meetings occur roughly every six weeks and are the single most influential event for the markets. Market participants speculate for weeks in advance about the possibility of an interest rate change that could be announced upon the end of these meetings. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching.

If the Beige Book portrays an overheating economy or inflationary pressures, the Fed may be more inclined to raise interest rates in order to moderate the economic pace. Conversely, if the Beige Book portrays economic difficulties or recessionary conditions, the Fed may see the need to lower interest rates in order to stimulate activity.

Since the Beige Book is released two weeks before each FOMC meeting, investors can see for themselves at least one of the many indicators which Fed officials will use to determine interest rate policy, and can position their portfolios accordingly.

International Trade Balance

Definition

International Trade measures the difference between imports and exports of both tangible goods and services. The level of the international trade balance, as well as changes in exports and imports, indicate trends in foreign trade.

Importance

International trade is the major indicator for foreign trade.

Why do Investors Care?

Changes in the level of imports and exports, along with the difference between the two (the trade balance) are a valuable gauge of economic trends here and abroad. Furthermore, the data can directly impact all the financial markets, but especially the foreign exchange value of the dollar.

Imports indicate demand for foreign goods and services here in the U.S. Exports show the demand for U.S. goods in overseas countries. The dollar can be particularly sensitive to changes in the chronic trade deficit run by the United States, since this trade imbalance creates greater demand for foreign currencies. The bond market is also sensitive to the risk of importing inflation. This report gives a breakdown of U.S. trade with major countries as well, so it can be instructive for investors who are interested in diversifying globally. For example, a trend of accelerating exports to a particular country might signal economic strength and investment opportunities in that country.

Interpretation

Market reaction to this report is complex. Typically, the smaller the trade deficit, the more bullish for the dollar. Also, stronger exports are bullish for corporate earnings and the stock market.

Both the level and changes in the level of international trade indicate relevant information about the trends in foreign trade. Like most economic indicators, the trade balance is subject to substantial monthly variability, especially when oil prices change. It is more appropriate to follow either three-month or 12-month moving averages of the monthly levels.

Frequency

Monthly

Source

Bureau of Economic Analysis and Bureau of the Census; U.S. Department of Commerce

Availability

Around mid-month.

Coverage

Data are for two months back. (Data for June are released in August.)

Revisions

Monthly, data for the prior three months are revised to reflect more complete information. The magnitude of the revision is typically small.

Consumer Confidence

Definition

A survey of consumer attitudes concerning both the present situation as well as expectations regarding economic conditions conducted by The Conference Board. Five thousand consumers across the country are surveyed each month. The level of consumer confidence is directly related to the strength of consumer spending. Consumer confidence and consumer sentiment are two ways of talking about consumer attitudes. Among economic reports, consumer sentiment refers to the Michigan survey while consumer confidence refers to The Conference Board's survey.

Why do Investors Care?

The pattern in consumer attitude and spending is often the foremost influence on stock and bond markets. For stocks, strong economic growth translates to healthy corporate profits and higher stock prices. For bonds, the focus is whether economic growth goes overboard and leads to inflation. Ideally, the economy walks that fine line between strong growth and excessive (inflationary) growth. This balance was achieved through much of the nineties. For this reason alone, investors in the stock and bond markets enjoyed huge gains during the bull market of the 1990s. Consumer confidence did shift down in tandem with the equity market in 2000 and 2001.

Consumer spending accounts for two-thirds of the economy, so the markets are always dying to know what consumers are up to and how they might behave in the near future. The more confident consumers are about the economy and their own personal finances, the more likely they are to spend. With this in mind, it's easy to see how this index of consumer attitudes gives insight to the direction of the economy. Just note that changes in consumer confidence and retail sales don't move in tandem month-by-month.

Current Account

Definition

A measure of the country's international trade balance in goods, services, and unilateral transfers. The level of the current account, as well as trends in exports and imports, are followed as indicators of trends in foreign trade.

Why do Investors Care?

U.S. trade with foreign countries hold important clues to economic trends here and abroad. The data can directly impact all the financial markets, but especially the foreign exchange value of the dollar. The dollar can be particularly sensitive to changes in the chronic trade deficit run by the United States since this trade imbalance creates greater demand for foreign currencies.

The bond market is sensitive to the risk of importing inflation or deflation. When Asian economies collapsed at the end of 1997, financial market participants feared that deflation in these economies would be transported to the United States. While goods inflation did decline modestly and momentarily, service inflation kept on ticking. Thus, the linkage is not so direct.

Leading Indicators

Definition

A composite index of ten economic indicators that typically lead overall economic activity.

Why do Investors Care?

Investors need to keep their fingers on the pulse of the economy because it dictates how various types of investments will perform. By tracking economic data like the index of leading indicators, investors will know what the economic backdrop is for the various markets. The stock market likes to see healthy economic growth because that translates to higher corporate profits. The bond market prefers less rapid growth and is extremely sensitive to whether the economy is growing too quickly-and causing potential inflationary pressures.

The index of Leading Indicators is designed to predict turning points in the economy such as recessions and recoveries. Incidentally, stock prices are one of the leading indicators in this index. However, it is important to remember that all the components of the index have been reported earlier in the month so that the composite index doesn't hold the same fascination for market players as it does for the non-financial media which tend to give it more press than it deserve.

Market Moving Economic Data

Definition

The Consumer Price Index is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Monthly changes in the CPI represent the rate of inflation.

Importance

The consumer price index is the most widely followed monthly indicator of inflation. The CPI is considered a cost-of-living measure since it is used to adjust contracts of all types that are tied to inflation. Labour contracts are tied to changes in the CPI; social security payments are tied to the CPI; and even tax brackets are tied to the consumer price index.

Why do Investors Care?

The consumer price index is the most widely followed indicator of inflation in the United States. Just knowing what inflation is and how it influences the markets can put an individual investor head and shoulders above the crowd.

Inflation is a general increase in the price of goods and services. The relationship between INFLATION and INTEREST RATES is the key to understanding how data like the CPI influence the markets (and your investments.)

If someone borrows $100 dollars from you today and promises to repay it in one year with interest, how much interest should you charge? The answer depends largely on inflation, because you know that the $100 won't be able to buy the same amount of goods and services a year from now, as it does today. If you were in Brazil where prices can double every couple of months, you might want to charge 400% interest for a total payoff of $500 at the end of the year. In the United States, the CPI tells us that prices are rising about 2% a year, so you only have to charge 2% interest to recoup your purchasing power at the end of the year. You might want to add in a few more percentage points to represent your profit, but the key variable in what interest rate you charge is the rate of inflation.

That basically explains how interest rates are set on everything from your mortgage and auto loans to Treasury bonds and T-bills. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates accordingly. The effect ripples across stocks, bonds, commodities, and your portfolio, often in a dramatic fashion.

By tracking the trends in inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform.

Interpretation

The bond market will rally (fall) when increases in the CPI are small (large). The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.

Frequency

Monthly

Source

Bureau of Labour Statistics, U.S. Department of Labour

Availability

Usually during the second or third week of the month.

Coverage

Data are for the previous month. (Data for June are released in July.)

Revisions

Monthly, none. Annually, new seasonal adjustment factors are introduced in February with the release of January data. This revision affects the last five years of data. The magnitude of revisions is minor.


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