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Making Sense of Economic Data

The Non-Farm Payroll Report. Crude inventories. The Federal Open Market Committee Minutes. If you aren’t an economist or passionately devoted to the financial media, you might have no clue what those are. But the reality is, if you’re an investor in the global marketplace and you own stocks and bonds, your money is likely reacting to these data points all year long. Having some insight into what these data points are and why they matter can prove to be useful if you look at them from the perspective of a long-term investor. At the very least, familiarity with how they’re used can demystify some of the financial jargon you read about and hear on television. And if that helps ward off the urge to make reactionary trades in response to every economic blip that causes market movement, so much the better.

The Role of Economic Data

There are a few reasons why economic data is gathered and reported to the public. One reason is to keep investors and anyone else who is interested up to speed on the health of the economy. Another reason is to more effectively correct problems that arise through an efficient system of identifying and monitoring economic trends. This is analogous to taking a blood test in order to monitor your cholesterol or glucose levels. Doing the test regularly can confirm good health or help to identify an early problem before it turns into something worse.

The reporting of consistent, positive data can also help to make our markets more appealing to both domestic and foreign investors. For example, our country regularly sells government bonds to the public. The sale of those bonds may be smoother when our economic indicators are broadly positive.

Our country's Gross Domestic Product (GDP) is one of the major data points that are released by the U.S. Department of Commerce each quarter. The GDP is an accounting of all the goods and services produced in our country each year. The market may form an opinion about the GDP number itself, or on the percentage growth or decline of the GDP over the prior quarter or year. The GDP number is significant in that it represents one measure of the nation's economic health. If the GDP is steadily growing, investors may interpret that as a good sign for U.S. businesses. If the GDP is declining, that may indicate an economic contraction, which could then cause investors to feel less confident about stocks.

The unemployment rate is another key measure of economic health, as told by trends in the work force. If the unemployment rate is low, that may signal that the economy is doing well. The logic there is that if more people are working, that should present itself positively in the form of increased company sales and more personal savings. If the unemployment rate is high or rising, that may imply the economy is struggling, perhaps because employers don’t feel confident enough to hire or aren’t growing quickly enough to support a larger payroll.

Other data points, which are shared on a regular basis, include housing starts, the consumer price index (which measures inflation), retail sales, and industrial production.

How Economic Data May Impact the Market

According to a research paper written by the Federal Reserve Bank of New York, certain announcements, including the Non-Farm Payroll Report, the GDP advance release, and the private sector manufacturing report, produce "economically significant" and "measurably persistent" results within the market.  When the results indicate economic growth, asset prices generally rise, and when they indicate economic contraction, asset prices generally fall.[1]

Some economic data is also categorized into either “leading” or “lagging” status. Leading indicators, such as bond yields, signal what may happen in the future. Lagging indicators, such as the unemployment rate, reflect what has already begun to take place in the economy.[2] There are also coincident indicators, such as personal income, which move in step with the current state of the economy.

How Investors May View the Release of Economic Data

The flow of economic data provides information to all investors about how the economy is faring at various points throughout the year. The fact that asset prices may react sharply to economic data should not be taken to mean that investors should time trades around these data releases. That sort of behavior could disrupt a carefully built asset allocation and potentially hinder your portfolio performance. Markets digest a lot of news, and on any given day, incoming economic data is just one set of inputs received by the market. If there is political friction on that same day, or if a big merger takes place, those news items could prove more important to the market.

If you maintain a long time horizon and understand that the market will inevitably receive some negative data as part of normal economic cycles, you may be able to turn bad news for the economy into good news for your portfolio by utilizing a routine, systematic investing strategy. Doing so will cause you to buy assets at random prices, including when they are cheaper due to normal market events.

[1] Bartolini, Leonardo: Current Issues in Economics and Finance: A publication of the New York Federal Reserve: August, 2008.

[2] Moffatt, Mike: A Guide to Economic Indicators: http://economics.about.com/cs/businesscycles/a/economic_ind.htm

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