Where's the Economy Headed? Key Economic Indicators Explained

Investors often try to predict what's going to happen next, or try to make sense of what's just happened. But there's no crystal ball. Instead, paying attention to the world around us can shed light on what's happening in the economy and markets — and what kinds of shifts we can expect. That's where key economic indicators can help.

There are three key types of indicators, and they're classified based on their relationship to economic change: leading, lagging and coincident. Broadly speaking, indicators can refer to trends, variables, data and other forces we can use to measure the economy. Below, we break down what each type of indicator can tell us.

Before you read on, consider this:

Attempting to forecast the economy or stock market is notoriously difficult — and inherently risky. And then there's that old saying: past performance doesn't guarantee future performance. For investors, it is important to consider economic indicators as just one tool they can leverage to help them understand the markets and the economy.

Leading indicators

Economists look at leading indicators to determine where the economy is headed. One reason investors tend to gravitate to these indicators is that they generally move in advance of a shift in overall economic conditions, giving observers a sense of the degree of expansion or contraction we can expect in a future phase of the economic cycle. Here are some examples:

• Average hours worked: This indicator differs from the unemployment rate in that it tracks the hours worked by those already employed. It stands to reason that if workers are reporting more hours, then employers must by increasingly busy — which some economists can interpret as certain segments of the economy outperforming.
• Stock prices: We've seen throughout the pandemic that surging stock prices don't necessarily indicate overall economic health. But this indicator is worth paying close attention to; in general, changes in the stock index can be an expression of investors' general sentiment toward the future of the economy.
• Retail sales: One of those knock-on effects is how much consumers are spending — which makes retail sales a strong indicator of both how much money Canadians are willing to spend and their level of confidence in continuing prosperity. It can give an investor a good sense of whether we're heading for economic expansion or contraction.

Lagging indicators

In contrast to leading indicators, lagging indicators confirm what has already happened to the economy. Economists can look at lagging indicators to measure roughly where we are in the current phase of the economic cycle. Here are some examples:

• Consumer Price Index (CPI): Canadians anxious about an increase in the cost of living may already be familiar with this one. CPI is a monthly measure of the prices associated with a specific basket of goods and services common to consumers, including food, transportation and clothing. This lagging indicator can give economists an idea of household cash flow.
• Unemployment rate: In general, if the unemployment rate is going down, that means that the economy is humming along nicely. On the other hand, if the unemployment rate is going up, it's an indication that the economy might be stumbling. For example, widespread job losses can have all kinds of knock-on effects, such as decreased consumer spending or a rise in foreclosures.
• Interest rates: With concerns about inflation top of mind, there's a lot of talk about interest rates and where they're heading. These rates represent the cost of borrowing money — so, when they go up, it means that borrowers might be more reluctant to ask banks for money. Discouraged borrowing can mean less money changing hands and slower business growth.

Coincident indicators 

Coincident indicators are up-to-the-moment or simultaneous information that reflects the current state of the economy — including whether it is currently growing or contracting. Here are some examples:

• Real Gross Domestic Product (GDP): This metric, which is a measure of the value of goods and services produced in Canada, signals the general health of the economy — when real GDP goes up, the economy is broadly seen as doing well. In order to get real GDP, the inflation rate is subtracted from GDP to take into account the rising price of goods and services.
• Personal income: In general, when personal incomes are rising then one can reasonably infer that the economy is healthy; conversely, lower personal incomes can be seen as a reason for concern. When people have more money in their pockets, they spend it to drive economic growth, creating benefits for any number of sectors.