“Economics is concerned with what emerges, not what anyone intended”.  – Thomas Sowell

Howdy, gang!  Of the three major economic categories, it is pretty obvious which one commands the most attention and importance.  Leading economic indicators tell us so much about our nation’s economy and correctly utilizing them can certainly help us create a dependable forecast of the markets.  Lagging indicators have their purpose, too.  By utilizing the data yielded by lagging economic indicators, we can more acutely take inventory of where we’ve been especially when we add the notion of hindsight being perfect vision.  The final category, coincident, is the lesser known of the three, but it would be a folly to assume that it is also of lesser importance.  Let’s take a look at what coincident indicators are and how we could possibly utilize them in our trading activities.

A coincident economic indicator is one that essentially shifts or moves in absolute value at the same time the economy (and/or stock market) does.  To give an example, the Gross Domestic Product is not only the largest economic report issued in our country, but also a coincident indicator.  As the numbers provided by the GDP report change, so does the economy.  The reason for this is because of the kind of data being measured.  If you think about it then you might be able to witness an “ah-ha” moment because the measurement of our nation’s Gross Domestic Product is merely a measurement of what is going on right now!  It’s not a measurement of risk, nor is it a measurement of forecasted growth.  It’s simply a measurement of what is!

To use an example, let’s take a look at Industrial Production, which is another coincident economic indicator.  The index of industrial production is available nationally by market and industry groupings. The major groupings are comprised of final products (such as consumer goods, business equipment and construction supplies), intermediate products and materials. The industry groupings are manufacturing (further subdivided into durable and nondurable goods), mining and utilities. The capacity utilization rate, reflecting the resource utilization of the nation’s output facilities, is available for the same market and industry groupings.  We’ll actually take a look at the capacity utilization rate for our example and continue to look at the period of “the Great Recession” because it’s such a good visual example.

Industrial production was also revised to NAICS (North American Industry Classification System) in the early 2000s. Unlike other economic series that lost much historical data prior to 1992, the Federal Reserve Board was able to reconstruct historical data that go back more than 30 years.  If we take what we know about the broad definition of coincident indicators and apply it to what we see from the Industrial Production report then we should be able to clarify and put into perspective what leading indicators can tell us.

Source: Bloomberg.com/markets/ecalendar

A careful look into the historical data of this report clearly shows a drop off in the capacity utilization rate starting from April 2008 until it bottomed out in March through June 2009.  A comparison of this information with the broad market activity of the same time period clearly shows that the broad markets (DOW, S&P500, for example) changed along with industrial production nearly in unison.  There may be some slight variances, but don’t confuse this graphical representation of capacity utilization with that of the stock market.  I think it’s pretty easy to see that there is a strong correlation between the overall direction and movement of the markets with what we see here with capacity utilization.  You may need to fire up your charting software and take a look at the broad markets (DOW or SP500) at the same time as shown in the graph above.  It’s uncanny how similar they look!  Thus, it is a coincident indicator.

We also notice that the data provided by this report has steadily increased since it bottomed out from March to June 2009.  If we are to believe that a recovery is underway then it would be essential for coincident economic data to mirror the pricing information provided by the stock market.  This kind of side-by-side comparative analysis is an easy way to confirm or disaffirm what we might be seeing in the stock market at any point in time.

The three categories of economic reports that we’ve just explored over the past few weeks can be very helpful in our daily grind of research and analysis in the stock market.  Becoming familiar with them can’t hurt and I personally hope that you are able to see just how it can actually help!  There is still an important classification that we will need to discuss in order to correctly and comfortably fit all of the various economic reports into our collective reasoning.  It will be essential that you understand if the report you happen to be looking at has a procyclic, countercyclic, or acyclic response/effect to the broad markets.  Knowing the distinction could make all the difference in your forecast of the markets if they are even remotely going to be based on any form of macroeconomic data.  We’ll take a look into those classifications in upcoming articles as we take yet another step towards increasing our economic acumen and overall forecasting abilities.

Be good.  Do good.  Know good.

Kleiny (@KnowGoodThings)

Columbus, Indiana