Leaders & Laggers

I might be completely wrong, but based on recent conversations, I guess that 9 out 10 romanians would only invest in the stock market, when they are sure that the general economy is booming.

The simple assumption, that better economic statistics and data, must be good for stocks, is unfortunately not true. If it where only that easy..

Why are better economic figures not necessary good for stocks?

Let’s assume you are turning on the TV and you see a smiling labor-minister who is telling the audience, that the jobless rate has declined and more people found work.

This is without a doubt a sign of a better or booming economy, but stocks will most likely not jump on this news.

The stock market is always trading future expectations. But a change in the jobless rate, announced today, had it’s roots in a growing economy 6 or 12 months ago. This makes the jobless rate a lagging indicator, who only confirms, what investors already assumed.

It gets worse, if the new, low jobless rate indicates a future shortage of workers, you shouldn’t be surprised when stocks tank after this supposedly good news of lower unemployment. Why?

If companies can’t find the people they need, they offer higher salaries.

That’s great for employees, but in view of the market this transforms into higher labor costs who could damage future earnings.

In plus, a possible worker shortage would most likely lead to higher interest rate, because the central banks job is then to tame inflation.

The anticipation of higher costs and higher rates is a dead sure recipe for lower stock prices.

When it comes to economic data the market makes a distinction between lagging and leading indicators. We already know, the jobless rate is lagging a few months, as it is the case of a change in the GDP numbers.

Leading indicators, on the other hand, change before economic adjustments and are therefore of much bigger importance for the market, only looking ahead and never back.

Leading indicators are for instance the order inflow in manufacturing, inventories, the number of building permits for private housing, consumer sentiment or the bond yields.

It is not necessary to go deeper into this indicators, because when it comes to future expectations, there is a lot of estimation, guess work, changes and contradictive numbers who only confuse.

But what is important to know is:

1. Better economic data means not necessary higher stocks
2. The stock market is trading the future and only the future
3. When future expectations are positive, stocks tend to rise in general, but not each sector surges the same way.

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The economic and the stock market cycle have both 4 stages. The first stage is already decisive for your success at the markets. Find out why in the next chapter: http://www.theleader.ro/economic-cycle-vs-market-cycle/