Multiple forces impact equity markets and influence the movement of stock prices, with the key economic indicators among the more important factors that do-it-yourself (DIY) traders and investors should consider when analysing markets and formulating their strategies.
These statistical measures reflect the overall health and performance of the economies in which listed companies operate and generate revenue, and various indicators are interconnected.
It is vital to understand these economic indicators and how they could potentially influence future economic growth and company performance, which can all have a significant impact on stock prices. These indicators are also a good starting point for any top-down analysis.
The main economic indicators to understand and incorporate into your trading and investment decisions include:
Gross Domestic Product
Gross domestic product (GDP) is defined as a comprehensive measure of the total market value of all goods and services produced within a country during a specific period, typically reported every quarter and annually, expressed in monetary units, such as US dollars (USD) or South African rands (ZAR), or the local currency of a country.
GDP represents the economic output of a country’s economy and is often used as a key indicator of its overall economic health. There are two main ways to measure GDP:
- Nominal GDP: This is the total value of goods and services produced in a country, using current market prices.
- Real GDP: This is nominal GDP adjusted for inflation, which provides a more accurate measure of economic growth over time.
Numerous elements contribute to a country’s GDP, including household consumption of goods and services, business spending on capital goods such as machinery and equipment, government spending on infrastructure, goods and services, and net exports (the difference between exported goods and services and imports).
Rising GDP generally indicates economic growth, which can boost investor confidence and lead to increased demand for equities and rising stock prices.
Conversely, declining GDP can signal an economic slowdown or recession, which results in risk-off sentiment and prompts investors to take a more cautious approach. Declines in GDP also impact company performance, which can negatively affect returns from equity investments.
Inflation
Inflation is defined as the sustained increase in the general price of goods and services over time.
While moderate inflation is generally considered normal for an economy, sustained high inflation can erode purchasing power and leads to uncertainty as rising costs force consumers and businesses to curtail spending on goods and services, which can result in an economic slowdown that impacts GDP growth.
Various factors cause inflation. For instance, when demand for goods and services exceeds supply, prices typically increase. This can result from supply-side constraints or logistics bottlenecks.
Rising input costs also increase the cost of production, which forces businesses to pass through the costs to consumers by raising prices to maintain profit margins.
If a central bank prints too much money, it can lead to inflation as there is more money in circulation paying for the same amount of goods and services.
The Consumer Price Index (CPI) is a common measure used to track inflation and gauge the purchasing power of consumers. CPI tracks the average change over time in the price of a basket of goods and services consumed by households.
Investors may be less willing to invest in stocks, particularly those in the consumer discretionary sectors during periods of high inflation due to the erosion of purchasing power, which can reduce corporate earnings. High inflation can also create uncertainty in markets about the future growth outlook for an economy.
Interest rates
Interest rates determine the cost of borrowing money. They represent the percentage of the principal amount that a borrower must pay to the lender as compensation for accessing the line of credit.
Central banks typically raise interest rates in response to rising inflation, and lower interest rates when inflation cools to stimulate spending in the economy.
Higher interest rates make borrowing more expensive and can constrain access to funding, which can slow economic growth and negatively impact equity markets as the costs of doing business increases.
Lower interest rates can stimulate economic activity and encourage borrowing, which can benefit businesses and boost equity returns due to increased market confidence.
Employment data
Employment data offer important insights into the health of an economy as these statistics relate to job creation and wage and salary growth.
A strong labour market with low unemployment and rising wages can indicate a healthy economy, which is usually characterised by increased consumer confidence and spending, which boosts investor confidence and buoys equity markets.
Conversely, a weak labour market, with rising unemployment rates and stagnant wage or salary growth, can signal economic challenges, leading to a decline in equity prices in certain sectors, particularly those in the consumer discretionary space.
Consumer confidence
Consumer confidence measures optimism about the economy and generally indicates future spending plans among consumers in a specific market.
High consumer confidence typically leads to increased spending, which can boost economic growth and raise equity prices, whereas lower consumer confidence can signal economic uncertainty and often leads to a decline in stock prices in certain sectors.
Corporate earnings
Corporate earnings refer to the profits that a company generates from its operations. It is the difference between a company’s revenue generated from the sale of goods or services and its expenses incurred in producing and selling those outputs.
Strong corporate earnings generally indicate a robust economy. When businesses are profitable, they tend to hire more employees, invest in growth, and contribute to overall economic activity. As such, strong corporate earnings typically boost investor confidence, and stock prices rise.
Conversely, weak corporate earnings can signal systemic economic issues, poor company management, or a business strategy that is failing to deliver the desired results, which can dampen investor sentiment and lead to a decline in equity prices.
Central banks may also consider corporate earnings data to inform economic policy decisions, lowering interest rates to stimulate economic growth in instances where corporate earnings are floundering.
Interpreting economic indicators
Understanding the impact of these economic indicators on equity markets can help DIY investors and traders make more informed decisions about their investments and develop considered strategies.
When analysing economic indicators, it is important to pay attention to the direction of changes over time to identify trends, rather than simply consider the absolute values.
