Economic Indicators and Predicting the Future

Sometimes I swear the market is blind and the journalists can’t read. The writing is on the wall, the data is there, the economic indicators are clear and all you need is common sense to put the pieces of the puzzle together.

I kind of get it though, sort of. It’s easier to follow the flock, be affected by confirmation biases, and all the rest, but buried amongst the noise are the clear economic indicators of what is to come, so why ignore them? With a mix of common sense, and time; reading these indicators can paint a pretty decent picture of plausible future scenarios.

But let’s side track for a moment and look at two quick scenarios. Economist or not, with only 5 data points you’ll be able to paint a picture of the future.

Country 1:

• Extremely high household debt
• Low to negative real wage growth
• Rapid housing price growth
• Rising home loan and consumer loan interest rates
• More money leaving the country than coming in

What’s going to happen?

Country 2:

• Sharply falling unemployment rate
• Modest housing price growth
• Low to modest real wage growth
• Low to modest household debt ratio
• Rising broad interest rates

What’s going to happen?

In just five data points you probably painted a pretty good picture of each country and what might happen within it. Consumer behaviour, economic performance and company performance can all be roughly estimated by taking an overview of the writing on the wall, the economic indicators.

In this article we’ll explore different indicators and why they should be used with a holistic common sense approach. But first, the markets ignorance and the journalists silence on these indicators is the more immediate trouble to delve into.

Market Lags

The market is made up of all these different participants, banks, hedge funds, superannuation funds, fund managers, retail investors, journalists and more. As a collective they are prone to herd biases and often ignore the real indicators for the ‘fake news’ and egging each other on.

This can be seen in both upswings and downswings. On the way up, the majority are reinforcing a belief of more profits and further gains. On the way down, everyone saw it coming, there is no bottom in sight and they feed on each others misery. The herd is constantly falling victim to collective hindsight bias and herd bias, which is why there are such sayings as:

“Be fearful when others are greedy, and greedy when others are fearful”

It’s relatively easy to see the noise as noise, but it’s virtually impossible to predict when the silence will start. The constant affirmation process of the market can push highly leveraged economics and high risk situations for years. The writing isn’t just on the wall, it’s a neon sign flashing in the black of night but for some reason the party continues.

An article will appear. Proclaiming all the strengths of the economy, valid points but failing to mention the risks. Think of the commentator like a teenage boy that’s evidently in love with a high powered motor bike, loving the wind in his face and the power in his hands but failing to mention that with just one small mistake, it all comes to a sudden end.

Journalists support this blindness and ignorance through a process of affirmation. A failure to provide the public with unbiased service, journalists look to fund managers and market players with direct interest in the market for quotes. Journalists feed the beast. Focused on their own bottom line and what will sell newspapers rather than an honest story about the economy we all live in.

The new age journalist often turns the morning ritual of reading the paper into a morning chore of filtering through the bias. A scavenger hunt for real information. We only need to look at political engagement or even political and economic education to understand that the populations of today are disengaged compared to our ancestors in times gone by.

Economic Indicators

So you want that crystal ball and the knowledge that what you see, will be. Well with that comes an infinite amount of frustration as you wait for the future to eventuate.

Economic indicators are never perfect and should never be used in isolation, but as a collection of indicators they paint a picture. It may not be a Monet but it’s still a pretty good impression.

A few key things to remember.

1. The economy is a group of people. People behave you expect people to behave. They do exactly what you think they’d do when things get scary and when things look great.
2. It’s about the flow of money. Where is the money going? Is into the country, or out of the country? Is it into productive investments that create jobs and stimulate the economy or speculative investments where we just expect capital growth just because?
3. It’s never certain. It’s all subject to change and big events change things, nothing is certain.

As we keep those things in mind let’s review a few indicators.

• GDP per capita: It should always be about per capita rather than just GDP. Population growth in most countries means that the GDP should almost always be growing, but is it going up per person or is each individuals share of GDP falling.
• Clearance rates: Clearance rates lead property prices and give a good indicator to the confidence of consumers. Are they feeling wealthy and that the future is bright enough to buy a home or are they retreating.
• Property prices: 500 years of data demonstrate that rapid rises in property prices, or asset prices precipitate a recession. There’s a huge amount of research and theory supporting this.
• Participation rate: The unemployment rate can be grossly misleading because it excludes so many people. With ageing populations in most countries around the world the unemployment rate should be falling. People are retiring. This doesn’t mean that they don’t exist though. It doesn’t mean that just because they’re retired that they don’t cost the government money in services. Look at participation rate rather than unemployment to see what portion of people are really working.
• Balance of payments: Is money coming in or out of the country? That’s the question here. Are other countries seeing this as a safe haven or good returns, and what impacts does their behaviour have on us.
• Household debt ratio: How leveraged are our everyday people. If they have more debt than they can poke a stick at, then how can we expect them to consume and fuel the economy.
• Retail sales: Retail sales are a great indicator of consumer attitudes and leveraging. If the household debt ratio has been growing to a high amount but now retail sales are falling then we can usually assume that households have reached their limit.
• Loan approvals: Are our banks leveraging up on a booming economy and providing easy access to credit? Or are they tightening up, or have people lost an appetite for debt? These all indicate something.

It’s all there and you can be an economic artist as well. Read widely and seek out the information. You might be surprised what common sense will tell you about the health and direction of a country.

Claude Monet

Don’t Be Misled

Do your best not to be misled by all the noise. Take it in with a grain of salt and remember that indicators such as inflation, wage growth, GDP and government spending by dollar amounts can all be grossly misleading. These metrics often fail to take into account population growth, or other aspects the economy that drive consumer outcomes and behaviour.

The economic data is always pointing to a particular direction. News stories and market commentators will be advising on what should or could be happening but there is often a lag between what they say and what common sense dictates.

Simple current examples include:

• The time taken to realise the impact of the Fed raising rates on emerging markets.
• The realisation of the impact the Australian Royal Commission would have on bank behaviour and consumer access to credit.

The writing is on the wall, the news outlets hang galleries of economic art, but the economic indicators are the true impressionists. Renoir, Monet, Degas and Morisot.

There will always be behavioural heuristics like herd bias, confirmation bias, and hindsight bias but you can create your own impression if you look carefully.

Please note this are is not financial advice, or views of any organisation, it is only the opinion of the writer. If you have any questions, or would like to see analysis on any particular topic please contact me.

Thank you for reading.

Yours,
Chris Leeson