How Can Economic Indicators Impact Stock Prices?

Economic indicators are an integral component of the financial markets, and they have a tremendous bearing on stock prices. This behind-the-scenes guide reveals all.

What Are the Most Important Economic Indicators for Stocks?

Economic indicators are metrics which assess the overall ‘health’ of the macroeconomy. The purpose of collecting this important information is to determine how well a country’s economy is performing. The most important economic indicator is Gross Domestic Product (GDP). This measures 4 core components, notably investment, government expenditure, consumption, and net exports.

Every country in the world, with the exception of the Himalayan Kingdom of Bhutan [they use a Gross National Happiness Index] uses GDP as its primary economic measurement index. GDP measures are often manipulated to fit a specific political narrative, particularly where issues of debt are concerned. Nonetheless, rising GDP levels generally bode well for stock market prices, while falling GDP levels tend to be harbingers of a pullback in stock-market performance.

CPI and PMI Indicators and their Impact on Stock Prices

The CPI and the PMI indicators are vital to the health of an economy. The consumer price index measures the price of a basket price of goods over time. It has a direct impact on the performance of corporations, given that inflation is the biggest driver of wealth erosion. The time value of money is an important concept; cash flows in the future are worth significantly less in the present.

The purchasing manager’s index serves an important role in overall economic activity. It evaluates important information collected from companies vis-a-vis production, employment, backlogs, deliveries, inventories, and new orders. The higher the PMI index, the healthier the economy. When real GDP is rising alongside low inflation with the CPI, and increasing PMI data, then stock-market performance is generally bullish. By contrast, bearish sentiment is to be expected when the numbers are lackluster.

The non-farm payrolls report (NFP) is another important measure used by traders and investors to gauge the ‘expected’ performance of the stock market. The US Department of Labor releases a monthly report on employment. This includes new jobs that have been created in the previous month, with the private sector, government sector (+ specific industries) as well as the attendant unemployment rates.

The NFP data is released by the Bureau of Labor Statistics. It provides specific guidance on what to expect in the market, given that traders are continually evaluating the underlying fundamentals for weaknesses and strengths. The headline payroll number is often regarded as the most important economic indicator in the NFP report. The employment rate (or unemployment rate) is equally important, and serves as an important barometer of macroeconomic health.

The biggest impact on the market comes from the NFP data. It unambiguously reflects the total number of jobs that were created. The number excludes certain jobs, including government jobs, private household employees, nonprofits and farm employees.

How Big an Impact do Economic Indicators Have on Stock Market Prices?

For the most part, there is an expectation with respect to economic indicators. While people may not know ahead of time what the precise number will be, the expected number is evaluated against the actual number. If a ‘surprise’ occurs, and the market outperforms expectations, then stock prices will surge. If, on the other hand, expectations are flattened and the reality is worse than analysts anticipated, stock prices will retreat.

Speculative sentiment is important in the economy, as it drives the behavior of market participants. When NFP data is bullish, traders and investors may be encouraged to actively buy up stocks in the hopes of generating greater profits. NFP data indicates job growth, and that bodes well for overall economic activity. The correlation between economic indicators and stock market prices generally move in tandem. Positive economic indicators are matched by increased demand for stocks. Negative economic indicators are a bellwether for decreased demand for stocks.

Other Important Indicators to Bear in Mind

Federal Reserve Bank Interest Rate Announcements

Interest rates have an outsized impact on stock market prices. When interest rates rise, this generally indicates less personal disposable income, a greater burden on companies with long-term loans and debt, and a fall in stock prices. It is not a linear correlation, and Federal Reserve Bank announcements of higher interest rates will not necessarily have an immediate impact on stock prices either.

Retail Sales

Retail sales figures represent all retail sales across the United States. This monthly report is an important economic indicator insofar as it determines the level of spending in the economy. The higher the level of spending, all things being equal, the better the health of the macroeconomy. When retail sales figures are plunging, stock markets tend to reinforce the negative trend.

Real GDP

Real GDP is an important economic indicator for stock markets. Real GDP takes account of inflationary pressures and provides an accurate representation of GDP performance. The higher the real GDP figure, the better. If real GDP indicates declining GDP growth, this will not bode well for markets. The percentage decline, or the percentage growth in real GDP is an important economic indicator as it relates to the value of goods and services produced by businesses. Real GDP growth is often assessed over time, not in isolated reports. A trend showing increasing real GDP is more valuable than a once-off quarterly decline in real GDP.

These economic indicators can all have an impact on stock prices. It is incumbent upon the individual trader or investor to independently evaluate the most important economic indicators as they pertain to specific stocks.

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