How seriously should you take economic indicators — those big-picture numbers, such as the unemployment rate, Federal Reserve short-term interest rates, the consumer price index and many others?
They’re like the climate, advisors and academics say: The indicators show us how the economy is doing in broad strokes, and whether it’s generally getting hotter or cooler. But on any given day, the weather where you live does what it does, regardless of what the climate charts say it should be doing. That’s why it’s smart to keep an eye on a few national economic indicators, but also pay attention to versions that show you more clearly what’s happening in your region or city or what’s relevant for your portfolio.
Here’s what to watch and why.
Interest rates and the Fed’s short-term lending rate.
Relevant for:
— Those who carry credit card balances
— Those who expect to be getting a home loan or big consumer loan (such as for a car)
— Understanding how the value of stocks and bonds are likely to change in your portfolio, in the broadest sense
It’s important to bear in mind, says Beverly Harzog, author of “The Debt Escape Plan: How to Free Yourself From Credit Card Balances, Boost Your Credit Score, and Live Debt-Free,” that the Fed does not set interest rates for consumer mortgages and credit cards.
“When the economy is going well, credit card interest rates come down and more people are approved, and when the economy tanks, the bar to get credit cards is much higher,” she says. “Most consumers do see the broad economy, but don’t look at specific indicators unless they have a specific interests.”
Advisors explain that low (some might argue, artificially low) interest rates are intended to spur easy borrowing that presumably results in growth. That may translate to investing in funds of small or medium-sized companies that have plenty of room for expansion. Conversely, advisors say, high interest rates introduce friction into the business climate, rewarding companies with plenty of internal resources for moderate growth, and those tend to be larger companies.
The unemployment rate.
Relevant for:
— Consumer-driven stocks and investments
— On a regional basis, tracking the local economy and home values
The unemployment rate is about more than how many people are working or not, says Deanna Sharpe, an associate professor of personal financial planning at the University of Missouri in Columbia, Missouri.
“Consumer spending is about 70 percent of overall economic activity. If unemployment is trending upward, consumers are typically pulling back their spending, either due to job loss or fear of job loss. Lower spending translates into lower corporate profits. So, the unemployment rate can be a useful indicator of potential trends in the value of stock of large retailers,” Sharpe explains.
But it’s your local unemployment rate that supports local hiring, business growth and home values, explains Hyrum Smith, assistant professor of personal financial planning at Utah Valley University in Orem, Utah.
“Local metrics are important if you are invested in local securities, or if you are invested in the industry in which you are employed,” he says. “In terms of home value, local factors will affect them, and national factors may not.”
To track the change in local home values, based on recent sales, use this calculator on the Federal Housing Finance Agency’s website. It is based on home sale prices for all sales, not only those sold through real estate agents.
Consumer price index.
Relevant for:
— Projecting your own cost of living versus your income
— Managing your portfolio to support your standard of living in retirement
The index is also known as the inflation rate. It measures the rise in price of goods and services. That’s especially important, Smith says, when you are trying to make sure you have enough streams of retirement income to cover your living costs.
By way of contrast, the gross domestic product, the total output of goods and services produced by the whole country, shows if the economy is growing, stagnant or shrinking, Sharpe notes. The GDP affects consumer and investor confidence, because people are willing to invest in a growing economy. But it’s not the same as the index.
Increases in Social Security benefits are based on the index, but you should also scrutinize pension payouts and insurance rates for cost-of-living escalators, Smith says. Currently, the inflation rate is about 2 percent, which is not much, but then, equally low interest rates on basic savings instruments won’t pull your returns ahead of the index either, Smith says.
“It’s important to understand where inflation is headed,” he says. “When retirees invest too conservatively and don’t generate enough income to maintain purchasing power, their standard of living erodes due to inflation. Even if you are very risk-averse, you need to maintain some equities and growth, whether it’s 20 percent to 30 percent of your portfolio, to protect against inflation.”
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3 Economic Indicators You Should Understand originally appeared on usnews.com
