How Understanding Economic Indicators Can Help Investors

A single data point can sway markets, but long-term trends are key.

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On Wednesday, U.S. stock markets finished lower after the Federal Reserve said economic growth had slowed in recent months. Last week, markets swung up and down based on good and bad news about the European financial crisis. Before that, the Dow Jones Industrial Average surged on the news that the housing crisis could finally be coming to a close.

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In each case, these market shifts were caused by what are known as economic indicators, or single points of economic data that show the direction of or sentiment about a specific part of the economy. There are indicators for all aspects of the economy, from consumer spending to housing to the yield on U.S. government debt. 

In recent months, these individual data points have deeply affected how stock markets perform each day. Since May, the Dow has fallen 1,000 points, but gained nearly all of them back.

These swings make for exciting days for traders. But they are nerve-wracking for average investors, who may experience big gains or losses based upon a seemingly irrelevant piece of economic data. And because of the slow summer and uncertainty about the presidential election, these swings are likely to continue into the fall.

U.S. News spoke to money managers about what indicators retail investors should watch when making investment decisions. Although one piece of data should not prompt action, a series of data points—some more important than others—can show where the market is likely headed.

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Spotting the trend. Lisa Kirchenbauer, president of Omega Wealth Management in Arlington, Va., says investors should not panic based on one data point, even if markets immediately react to it.

"The most important thing consumers and investors can do is to not read too much into short-term numbers," Kirchenbauer says. "For one thing, many of the numbers issued by the government are adjusted in later months. So, reacting too strongly either way to an indicator can be counter-productive."

Kirchenbauer says the key to understanding indicators is to spot larger trends. One positive indicator might sway the market for a day or two. But a series of positive indicators has the ability to affect the market over the long term. "I think it's more important to look at the trends over a period of months and even years," she says.

Ernest Dawal, chief investment officer of wealth and investment management for SunTrust Banks, adds that investors should ignore shocking headlines and understand how indicators can help long-term planning.

"Any headline, any economic news, and single data point doesn't make a trend," he says. "Whether we see a weak number or strong number, it's not until subsequent reports that we're going to see what the underlying data points mean."

Key points to watch. However, both Kirchenbauer and Dawal say there are economic indicators that are especially important for consumers and investors. These points, more so than data related to foreign bond yields or the value of the euro, are closely correlated with the direction of the U.S. economy.

For Kirchenbauer, the most relevant indicators are tied to consumer behavior, meaning the indicator is directly affected by the choices consumers make. "I would be focusing on housing related numbers, but … look at the trends, not just this month's numbers," she says. "I think that retail sales remain important given our consumer-driven economy."

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"Unemployment numbers are a great example of an indicator that you need to take with a grain of salt, since they are almost always revised in the following months [and] they have all kinds of seasonable adjustments that may or may not show an accurate picture," she adds.

Kirchenbauer also says investors should pay attention to numbers related to the construction industry, and that manufacturing new orders can show whether consumer demand is growing or shrinking. "Consumer expectations may be worth watching, but can also be overly optimistic or pessimistic depending on what is going on economically and politically," she says.