Friday, September 16, 2011

Economic Indicators Brightening

There are many indicators which attempt to gauge the health of the economy. They are broadly divided into three categories: leading (e.g. building permits), coincident (e.g. retail sales) and lagging indicators (e.g. employment data). Focusing on a single indicator, or even a single category, does not give the analyst a good enough gauge of the future of the economy. For this reason, many (including value investor Ken Fisher) consider the ratio between the coincident and lagging indicators to be the single best measure of the direction of the economy.

A chart of this index over the last five years is below:

Back in 1992, Fisher argued that "when this ratio is rising sharply, always be bullish" and "when it is falling, adopt your most bearish posture". Based on those assertions, it would appear that this indicator started to warn of the current recession in late 2006, well before the market recognized that there were any problems. Furthermore, this ratio started to tick up in early 2009, which was exactly the right time to buy stocks.

Unfortunately, the ratio has been on a downward slope for the last few months, which hasn't been a good sign for the economy. At the same time, however, there is a slight uptick recently, suggesting things may be getting better (though it is not rising sharply by any means).

Investors interested in determining the strength of the economy in the short-term should keep an eye on this ratio, and can do so here.


Roshama said...

Very interesting. Do you use this ratio at all in your investing process?

Saj Karsan said...