What Lagging Economic Indicators Tell You
Three Indicators to Watch Right Now
Lagging indicators are statistics that follow an economic event. You use them to confirm what has recently happened in the economy and establish a trend. That makes them especially useful for identifying turning points in the business cycle.
The best way to use lagging indicators is in conjunction with the two other types. The first are leading indicators. These include stock prices, manufacturers' orders for durable goods, and interest rates. They predict new phases in the business cycle. These indicators are better understood with some foundational knowledge on what causes the business cycle.
Most people don't bother looking at lagging indicators. That's a mistake. They help you make sure you are reading the trends right. That way you'll know that the economy has headed into a recession and when it's over.
Top Three Lagging Indicators to Watch
The Dow Jones Transportation Average is a useful lagging indicator. It tracks the stock performance of companies that ship our nation's goods. Once manufacturers fill the durable goods orders, they have to ship it to customers. There's a lag between the order and the shipments. If the Transportation Index rises, it means customers haven't canceled their orders. That confirms the movements of the Durable Goods Order Report, a leading economic indicator.
Unemployment is a lagging indicator. Once people start to lose their jobs, the economy has already begun declining. The last thing employers want to do is let people go. Unemployment will also continue to rise even after the economy has started to improve. Companies wait until they believe the economy has recovered before they start hiring again.
Another lagging indicator is the Consumer Confidence Index. Most people don’t feel that the economy has changed until after it already has. People base their feelings about the economy on how easy it is to find jobs. It doesn't become difficult to find work until after the economy has turned negative.
The U.S. Conference Board established the Index of Lagging Indicators for the federal government. This non-profit agency publishes the index monthly. It weighs seven lagging indicators to create the index. The Board used the indicators established by The National Bureau of Economic Research. NBER’s research identified them as the ones that best confirmed business cycle phases.
Here's a list of the Conference Board's indicators. It's the most comprehensive list of useful indicators that economists follow. A quick summary explains why each is useful and their weight in the index.
- Average Duration of Unemployment. The number of weeks in which the unemployed, those counted as such by the Bureau of Labor Statistics, have been looking for a job. During a recession, the number of long-term unemployed increases. Weight = 0.0361
- Inventories to Sales Ratio. The Bureau of Economic Analysis calculates this for manufacturing, wholesale, and retail companies. During a recession, inventories rise as sales decline. Weight = 0.1211
- Change in Labor Cost per unit of Manufacturing Output. This number increases when factories produce far less per employee, due to slower orders. The only way to reduce this number is to lay off workers or produce more. Weight = 0.0587
- Average Prime Rate. When times are good, banks resist lowering rates and consequently, their profits, even if business starts to slow. When times are bad, they resist raising rates until they are sure the demand supports it. Weight = 0.2815.
- Commercial and Industrial Loans. This is a lagging indicator because banks still have a lot of loans in the pipeline even after a recession starts. Similarly, businesses that are losing revenue in the beginning stages of a recession will take out loans to cover costs. Once the economy begins to improve, it takes a while before banks have enough liquidity to start lending again. Weight = 0.0970.
- Consumer Debt to Income Ratio. Consumer debt statistics are compiled by the Federal Reserve. Personal income is reported by the Bureau of Economic Analysis. After a recession, consumers cautiously hold off accumulating debt even though their income starts to rise. Conversely, they will borrow more during a recession to pay bills when they get laid off. Weight = 0.2101.
- Consumer Price Index for Services. This is a part of the Consumer Price Index. Service providers may raise prices at the beginning of a recession to maintain profit margins as demand falters. Once the recession hits, they are forced to cut costs and lower prices. They may keep cutting prices, even when the recovery has begun. Those that remain after a recession are likely to continue lowering prices. They keep trying to gain more business because it worked. They don't recognize when the recession is over. Weight = 0.1955.