The unemployment rate, business profitability, and labor cost per unit of output are all instances of lagging indicators. Interest rates can also be useful trailing indicators because they fluctuate in response to market volatility. Economic indicators such as the gross domestic product (GDP), the consumer price index (CPI), and the balance of trade are examples of lagging indicators (BOT).
What makes GDP a lag indicator?
GDP is not a perfect metric. Because of policies like quantitative easing and excessive government expenditure, GDP, like the stock market, can be deceiving. Some doubt the true value of the GDP number as a lagging indicator. After all, it only informs us what has happened in the past, not what will happen in the future.
GDP is a type of indicator.
Several economic indicators fall into one of the three categories described above. Each of them has the potential to assist investors, economists, and financial analysts in making sound financial decisions.
Gross Domestic Product (GDP)
The gross domestic product (GDP) is a lagging indicator. It is one of the first measures used to assess an economy’s health. It denotes economic output and growth, as well as the size of the economy. GDP measurement can be difficult, however there are two primary approaches.
The income approach is one method of measurement. This method totals what everyone earned in a year, including gross profits for both non-incorporated and incorporated businesses, taxes minus any subsidies, and total remuneration for employees. The spending method is the alternative option. This technique adds up total consumption, government spending, net exports, and investments over the course of a year. These two measurements should yield about the same results. The expenditure method, on the other hand, is more often used since it incorporates consumer spending, which accounts for the vast bulk of a country’s GDP.
GDP is frequently stated as a percentage of the previous quarter or year’s GDP. For example, if a country’s GDP increased by 2% in 2018, the economy of that country grew by 2% since the last GDP measurement in 2017. Annual GDP estimates are frequently regarded as the most accurate indications of the economy’s size. When measuring a country’s economy, economists utilize two categories of GDP. Inflation is factored into real GDP, but it isn’t factored into nominal GDP.
When the GDP rises, it means that firms are making more money. It also implies that the country’s citizens will have a higher level of living. If GDP falls, it means the opposite is true.
The market’s reaction to GDP changes may also be influenced by how one quarterly GDP metric compares to previous quarters as well as economists’ forecasts for the current quarter.
The Stock Market
A leading indication is the stock market. Even if it isn’t the most crucial signal, it is the one that most people look to first.
Stock prices are dependent in part on what corporations are predicted to earn in the future. The stock market can forecast the economy’s path if corporations’ profit predictions are accurate. A down market, for example, could imply that overall corporate earnings are projected to fall, and the economy is on the verge of a recession. An up market, on the other hand, could indicate that profit projections are rising and that the economy as a whole is doing well.
The stock market isn’t always a reliable leading indicator. Earnings forecasts may be inaccurate, and the stock market is susceptible to manipulation. Complex financial derivative methods, high-volume trades, and creative accounting principles can be used by Wall Street businesses and traders to inflate stock prices. (Creative accounting as practiced on Wall Street isn’t necessarily legal.) Furthermore, the government and the Federal Reserve have used federal stimulus money and other tactics to maintain markets high in the case of an economic crisis, in order to avert public panic. A stock or index price is not always an accurate indication of its value because the market is susceptible to manipulation.
Stock market bubbles can also provide a false positive for the economy’s trajectory. A market meltdown could occur if investors overlook underlying economic indicators and price levels rise without support. When the market crashed in 2008 due to inflated credit default swaps and subprime loans, we saw this.
Unemployment
Unemployment is a lagging indication when it comes to economic indicators. The Bureau of Labor Statistics publishes a monthly estimate of the total number of jobs lost or gained in the previous month, as well as a percentage figure indicating how many Americans are unemployed and actively seeking work.
A monthly poll of 60,000 households is used to calculate the unemployment rate. It calculates the percentage of Americans who were unemployed at the time the survey was conducted. Only those who are unemployed and seeking for work are counted in the unemployment rate.
Other than general government employees, workers in private households, employees of non-profit organizations that offer aid to persons, and farm workers, non-farm payrolls represent the entire number of workers employed by U.S. enterprises.
The number of jobs created or lost in a month is a leading indicator of economic health and has a big impact on the stock market. When businesses hire more people, it indicates that they are doing well. More hiring can also lead to assumptions that more people will have more money to spend because there will be more people working.
When unemployment rates rise unexpectedly or diminish more slowly than expected, it can lead to a dip in stock values since it suggests that firms are unable to hire as many workers. Remember that how an economic indicator performs in comparison to expectations is critical.
Consumer Price Index (CPI)
CPI is a lagging indicator, yet it is one of the best indicators of inflation in the United States. This is due to the fact that increases in inflation might compel the Federal Reserve to alter its monetary policy.
For a given month, the CPI tracks changes in the prices paid by urban consumers for goods and services. It’s essentially a measure of changes in the cost of living. It provides a measure of inflation in terms of buying such goods and services.
The Consumer Price Index (CPI) is based on a random sample of several hundred goods and services from 200 different categories. The Bureau of Labor Statistics collects this information in 87 cities across the United States through phone calls and personal visits. The CPI excludes Social Security taxes, income, and stock, bond, and life insurance investments. It does, however, contain all sales taxes related to the purchase of those items.
Producer Price Index (PPI)
PPI is a price index that tracks changes in practically all goods-producing industries, including mining, manufacturing, agriculture, forestry, and fisheries. Price movements in non-goods-producing sectors of the economy are increasingly being tracked by the PPI. Prices for finished goods, intermediate goods, and crude commodities are all measured in the report. Every month, the prices of thousands of establishments are tracked and recorded on the website of the United States Bureau of Labor Statistics.
PPI is significant since it is the first gauge of inflation available each month. It catches pricing changes at the wholesale level before they appear at the retail level.
Balance of Trade
The trade balance is a lagging indicator. It’s the difference between the value of a country’s imports and exports, and it indicates whether the country has a trade surplus or deficit. A trade surplus is generally good since it indicates that more money is entering the country than is leaving. A trade imbalance indicates that more money is being sent out of the country than is being brought in. Domestic debt can be exacerbated by trade deficits. A trade imbalance, which leads to large debt, might lead to a devaluation of the local currency in the long run. The local currency’s credibility will be harmed if debt levels rise. It may also place a significant financial strain on future generations, as they will be required to repay the loan.
However, if a country’s trade surplus is too large, it may be missing out on opportunities to buy goods from other countries. In a global economy, countries specialize in producing specialized items while purchasing things that other countries make more effectively and at a lower cost.
Housing Starts
Starting construction on a home is a leading indicator. Every month, the US Census Bureau publishes data on housing starts. Housing starts are a monthly estimate of the number of housing units on which some work was done. Data is available for both multi-unit structures and single-family residences. The information also shows how many building permits were issued and how many dwelling development projects were started and completed.
Fluctuations in mortgage rates, which are influenced by interest rate changes, have a significant impact on housing starts. Despite the fact that home starts are a very volatile indicator, they account for around 4% of yearly GDP. As a result, they are able to detect the effects of present financial conditions as well as economic developments. Housing starts are monitored by economists and analysts for longer-term trends.
Interest Rates
Interest rates are a lagging predictor of growth in the economy. They are based on the Federal Open Market Committee’s determination of the federal funds rate (FOMC). Interest rates rise as the federal funds rate rises. As a result of economic and financial developments, the federal funds rate rises or falls.
Borrowers are less willing to take out loans when interest rates rise. As a result, consumers are less likely to take on debt and firms are less likely to expand, and GDP growth may stagnate.
If interest rates are too low, it can lead to an increase in money demand and, as a result, inflation. Inflationary pressures can affect the economy and the value of a country’s currency. Current interest rates are a reflection of the economy’s current state and can also predict where it is headed.
Currency Strength
The value of a currency is a lagging indication. When a country’s currency is strong, it has more purchasing and selling power with other countries. A country with a strong currency can import goods for less money and sell them for more money in other countries. When a country’s currency is weak, it can attract more tourists and encourage other countries to purchase its commodities since they are cheaper.
Manufacturing Activity
Manufacturing is a leading indicator of the economy. Orders for durable products are a measure of manufacturing activity. Consumer products that aren’t replaced for at least a few years are referred to as “durable goods,” such as refrigerators and automobiles. The Census Bureau of the Department of Commerce releases its report on durable goods near the end of each month.
Durable goods orders are a measure of fresh orders for those goods received by manufacturers. A rise in durable goods orders is often regarded as a sign of economic health, whereas a drop could suggest economic difficulties. Increases and reductions in durable goods orders may be linked to stock index increases and falls, accordingly.
Income and Wages
Wages and income are lagging indicators. Earnings should increase to keep up with the average cost of living when the economy is functioning correctly. When incomes fall below the average cost of living, however, it indicates that firms are laying off workers, reducing pay rates, or reducing employee hours. Declining incomes can also signal that investments aren’t functioning as well as they should.
Different demographics, such as age, gender, level of education, and ethnicity, are used to break down incomes. These demographics can reveal how certain groups’ incomes fluctuate over time. A tendency that appears to harm only a small group of people may actually indicate an income concern for the entire country, not just the group it initially affects.
Consumer Spending
The US Census Bureau issues its retail sales data on or around the 13th of each month. This report has the appearance of being a leading indicator, but it is actually a coincident indicator. Because decreases can arouse fears of a recession, and increases frequently precede higher CPI numbers, this is the case.
The retail sales report is a total sales measure for all retail stores in the United States. Its rise and fall can directly affect the stock market, or at the very least the retail industry. Consumers spend more when sales are higher, and businesses tend to perform better. The opposite is true when sales are down.
In performance measurement and management, the terms “leading indicator” and “lagging indicator” have become commonplace. However, the line between the two might be blurry at times; some indications, for example, are a mix of the two.
If managers are to develop an accurate understanding of performance, they must first understand the differences between the two and make sure they have both types of metrics in place.
The most effective way to manage performance is to combine data from backward-looking indicators (your lagging indicators) with more forward-looking data and predictions (your leading indicators).
Assume your company is an automobile. Leading indicators are those that glance forward, through the windshield, at the road ahead of them. Lagging indicators gaze backwards out the back window at the road you’ve already driven.
A financial indicator such as revenue, for example, is a lagging indicator because it reports on what has already occurred. Last year’s revenue does not, strictly speaking, foretell future revenue (although it has been used to do just that by many businesses in the past). Customer satisfaction, on the other hand, is a predictor of future revenue because happy consumers are more likely to repurchase and tell their friends about your business. As a result, customer satisfaction is a leading indication.
The goal of leading indicators is to forecast the future. The word “leading indicator” comes from economics, where it refers to a measurable economic component that changes before the economy begins to follow a specific pattern or trend. For example, the amount of mortgage defaults can foretell negative economic changes.
Forward-looking indicators in business include brand awareness, new product pipelines, and expansion into new markets or sales channels, all of which point to patterns that help forecast future performance. Customer happiness can predict customer loyalty (and, as a result, future revenue), whereas employee satisfaction can predict employee retention (and, in turn, performance and productivity).
Because they provide information about expected future outcomes, leading indicators are useful for developing a broad knowledge of performance. They aren’t, however, flawless. For starters, they aren’t always correct. Many of us were perfectly content with our old Nokia phones, for example, but when smart phones became available, we moved to Apple or Samsung! As a result, think about leading indicators in terms of what might happen rather than what will definitely happen.
Furthermore, leading indicators are more difficult to spot than lagging indicators (which tend to be pretty standard across industries). Leading indicators are more likely to be unique to your organization, making them more difficult to develop, assess, and compare.
Lagging indicators, such as revenue, profit, and revenue growth, tell you about what has already transpired. Lagging indicators are useful because they are often straightforward to detect, measure, and compare to other indicators in your business.
Backward-looking indicators, on the other hand, have the obvious disadvantage of providing information too late to do something about it. It’s too late to stop half your clients from defecting to the competition by the time you discover it. Even if it isn’t too late, the lagging indication is unlikely to reveal why this trend is occurring or what you may do to reverse it.
Another disadvantage of trailing indicators is that they foster a focus on outputs (numerical measures of what has occurred) rather than outcomes (what we wanted to achieve). Anyone who travels by train in the UK on a frequent basis will be familiar with one such scenario. The train operator uses the number of trains that arrive at their final destination on time as a lagging indicator. To ensure that this indicator is met, the operator adjusts the service on a regular basis, skipping smaller stations along the route in order to arrive at the final station on time. Customer satisfaction, which is probably more crucial, suffers as a result of this.
Because of the emphasis on achieving trailing indicators (and the ease with which it is to cheat the system to achieve them), lagging indicators are frequently given precedence over leading indicators, even though leading indicators would be far more valuable for analyzing and improving performance.
The goal of using indicators to measure performance is to have a better understanding of it and to find strategies to enhance it in the future. Both types of indicators are required to do this task successfully.
It’s also worth remembering that various indicators might be leading and lagging at the same time. For example, while being able to acquire the top personnel may be a lagging signal for HR (as in, has HR put in place the proper systems and processes to recruit the best people? ), it is a leading indicator for the organization as a whole, as it should translate into improved future business performance.
That’s why, when I help a customer outline their approach, we put together a “plan on a page.” This section divides the company’s strategy into numerous important areas or “panels,” such as finance, customer service, and human resources, and specifies the expected goals for each. You may identify the correct combination of leading and lagging indicators to provide a detailed picture of performance by focusing on outcomes (and the actions/inputs that will go into reaching those results).
If you want to learn more about KPIs and performance measurement, read my articles on:
- What is the difference between KPIs and CSFs (Key Performance Indicators and Critical Success Factors)?
Is GDP a metric or an index?
GDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP FormulaGDP Formula The monetary worth, in local currency, of all final economic goods and services produced in a country over a certain period is usually considered as the primary indicator of macroeconomic performance.
- A hotel resort might use ABS and Tourism Research Australia statistics on local and international visitor numbers and spending trends, as well as the currency rate, which is critical for any company exporting or importing from another country.
- Data on stock market performance and consumer confidence should be monitored by a private school board since they could be leading indicators of parents’ ability to pay school fees and avoid falling behind on payments.
- Building approvals data, which is a leading predictor of construction activity, should be considered by a construction business.
- Businesses with a lot of interstate or international travel should keep an eye on the oil price, which is now at very low levels, because it has a big impact on flying costs.
In conclusion, paying attention to pertinent economic data can help board directors have a better understanding of the industry they operate in, as well as future prospects and hazards. There are numerous resources available to assist directors in this endeavor, and a few suggested ones to start with are given below.
The RBA chart pack is a great resource for both domestic and international economic statistics: http://www.rba.gov.au/chart-pack/index.html
http://www.rba.gov.au/monetary-policy/ RBA monetary policy information, including Board minutes and the Statement on Monetary Policy: http://www.rba.gov.au/monetary-policy/
http://www.budget.gov.au/ Australian Government Budget, including Economic Outlook
Gene Tunny is a Principal at Adept Economics and a Specialist Adviser at Effective Governance.
Is the EMA considered a lagging indicator?
The EMA is a trailing indicator that is derived from the SMA calculation, with the exception that it favors more recent price changes.
Is GDP a reliable economic metric?
GDP is significant because it provides information on the size and performance of an economy. The pace of increase in real GDP is frequently used as a gauge of the economy’s overall health. An increase in real GDP is viewed as a sign that the economy is performing well in general.
Quiz: What are lagging indicators?
When information is released after the period to which it corresponds, it is referred to as a lagging indicator. Economic data is provided via lagging indicators, which indicate previous levels of economic activity.
What do leading and trailing indicators look like?
Leading and lagging indicators are two types of metrics used to evaluate a company’s or organization’s success. A leading indicator is a measurement that predicts something, such as the percentage of people wearing hard hats on a construction site. A lagging indicator is a measurement of an output; for example, the number of accidents on a construction site is a lagging safety indicator. A leading indicator can affect change, whereas a trailing indicator can just reflect what has occurred.