Share Market -
Macro indicators to check before investing..!
by Mr. P
Saravanan, IIM Shillong
Often it is said that
stock market indices are the barometers of a country’s economy. There exists a
strong link between the overall economic environment in a country and the
performance of its stock markets.
Stock markets reflect
what is expected to go on in an economy because the value of a share is
determined by its expected cash flows and its future required rate of return,
and both of these factors are influenced by its expected aggregate economic
environment.
Let us discuss certain
key economic indicators.
1. Leading indicators
These are the indicators
which usually reach peaks or troughs before corresponding peaks or / troughs in
aggregate economic activity. Leading indicator approach for analysis of
business cycles and growth cycles is used by many countries.
We have leading
indicators proposed by National Bureau of Economic Research (NBER),
Organisation for Economic Co-operation and Development (OECD) and World Bank.
But these indicators are
not directly applicable to the Indian context. Accordingly, Reserve Bank of
India and National Bureau of Economic Research came out with some appropriate
indicators.
Some of the leading
indicators are Index of Industrial Production (IIP) growth cycle, manufacturing
activity, inventory level, retail sales, building permits, level of new
business start-ups, etc.
Among all the indicators
it is empirically proved that the IIP growth cycle has a forecast horizon of
four months. In terms of back performance, the IIP growth cycle has been able
to track all the turning points in advance.
2. Lagging indicators
These are the indicators
which usually change after the economy expands or contracts in the aggregate
economy. Typically, lagging indicators are output based.
They are generally easy
to observe and measure but difficult to improvise or influence, whereas leading
indicators are input oriented and easy to influence.
Lagging indicators are
those indicators such as change in GDP rate, interest rate, inflation rate,
unemployment rate, currency strength, corporate profit, balance of trade, etc.
3. Co-incidental factors
These are the important
indicators such as employment, real earnings, average weekly hours worked in
manufacturing, etc. , as they depict the current economic activity in an economy.
To track the movement of the current economic condition of the Indian economy,
two Composite Index of Coincidental Indicators (CICI) have been constructed for
the two-reference series, viz., the monthly IIP and quarterly GDP growth rate
cycles.
The CICI for the monthly
IIP growth rate cycle has been constructed based on three economic indicators,
viz., IIP - Intermediate Goods, IIP - Consumer Durables and Bombay Stock Price
Index 30 script.
In terms of back
performance, the CICI has been able to track all the turning points
synchronically with the reference series to a greater extent.
4. Which one to use?
Both lagging and leading
indicators are critical. Using only lagging indicators is like trying to drive
your car using only the rear view or side mirrors. It is great for backing out
of the driveway or parking your car.
Moving forward is
difficult, if not impossible. Some of the most important information you need
to invest, avoid peril and successfully navigate the financial path are things
you can see before you are there. Leading indicators let you know what to expect.
They help with
forecasting and predicting where your economy is going and protect you from
falling off the cliff.
As the health of the
economy is intimately connected to various indicators as discussed above it is
essential to accurately characterise the state of the economy.
You must rely on your
own analysis or perhaps the analysis of others without a pre-conceived idea.
By considering the
entire picture, you can thereby make better decisions regarding your overall
financial plan and investments.
About the author..
Mr. P Saravanan is
associate professor of finance & accounting, IIM Shillong
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