Macro-Economic Trading

The Average Workweek (Recession Indicator)

The average workweek measures the number of hours people have worked. This is considered a leading indicator of economic activity. This is because businesses will increase the number of hours their workers put in as a first step before hiring new workers. When the average workweek increases in the early stages of a business cycle, this may be the first sign that employers may begin to augment their payroll – this is a bullish sign. On the other hand, when the work week is rising late in the business cycle, this may indicate a tight labor market and potential wage inflation – a bearish signal.

Buy strong stocks in strong sectors in market uptrend

Short weak stocks in weak sectors in market downtrend.

GDP

Although the GDP gives us an accurate measure of the economy over the long term, the report is quarterly and the information is highly volatile. Most often, the information we get from the GDP data can be obtained from all the other data available.

The GDP equals consumption plus investment plus government spending plus net exports.

Consumption

Two-thirds of the GDP data is as a result of consumption. If consumers stop spending, economic growth will come to a halt.

Retail Sales

Retail sales provide us with very important evidence of consumer patterns for the month as well as the most timely indicator of broad consumer spending patterns. This report is a key stock market mover and any unexpectedly negative retail sales can result in a massive sell-off. When examining this report, one should look to see if any changes in consumption patterns are broad based or linked to specific sectors.

Personal Income and Consumption

The largest component of personal income is wages and salaries. Other categories of income include rental income, government transfer payments such as social security payments to retirees, subsidies like welfare and dividend and interest income. This data which is released on the first day of the business month for the two months prior is not as critical as the retails sales data, but it does provide further insight into economic activity.

Consumer Confidence

Two separate consumer confidence reports are issued monthly by private institutions – one by the Conference Board and the other by the University of Michigan Survey Research Center. The future expectations portion of this report is considered a leading economic indicator. The data collection for these two reports is conducted in a similar fashion. A monthly survey asks 5000 households about their current appraisal of current economic conditions as well as their expectations for the future. Questions about future purchase of big ticket items like houses, cars appliances are also on the survey. Future expectations make up about 60 percent of the report, while current conditions account for 40 percent.

Consumer Credit

Because it is highly volatile and subject to large revisions, the consumer credit data, which is published monthly, is not considered to be very important by the market. The data is broken down into three categories: autos, credit cards and other revolving credit and the ominous “other” category.

Investment and Production

Investment spending accounts for less than 20 percent of the GDP (compared with 70 percent for consumption spending). It is important to the market because of its volatility and its sometimes dramatic effects on the business cycle. During an economic expansion, the growth in investment usually grows faster than actual GDP growth and it also declines faster during a recession. The investment indicators include the Purchasing Managers’ Report, business inventories and sales, durable goods and factory orders.

The Purchasing Managers’ Report

This report, published by the National Association of Purchasing Managers, surveys purchasing managers in more than 300 companies representing 20 industries in 50 states of the country. This report comes out on the first of the month and so the trader gets very useful information very early, hence this is a very closely watched report.

The Purchasing Managers’ Index is a composite of five series dealing with new orders, production, slow delivery performance, inventories and inflation. New orders are considered a leading indicator for obvious reasons. Production and employment are coincident indicators representing the current status of the manufacturing sector. Inventories is a lagging indicator because the build-up of inventories will occur after a downturn has begun. Slow delivery performance (supplier delivery or vendor performance) is a key component of the index of leading economic indicators. The Purchasing Managers create what is known as a “diffusion index” from these five series. The total index is based on these weights: 30 percent for new orders, 25 percent for production, 20 percent for employment, 15 percent for deliveries and 10 percent for inventories. This diffusion index is very different from the numbers reported on Wall Street. It is calculated by adding the percentage of positive responses to a half of those responses that were unchanged. For example if 80 percent of managers say that things are unchanged and 24 percent report positive responses then the index will be at 52. The manufacturing sector is considered to be in expansion phase for any number over 50.

The adroit trader will also look at some of the individual components of the index. New orders and slow delivery performance are leading indicators and those would be good ones to watch for changes in the business cycle and market trend. The purchasing managers’ report fits in snugly with the durable goods order, the index of industrial production and the jobs report. When all these star reports are aligned, it is hard to argue with whatever trend they suggest.

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