Leading Indicators and the Business Cycle: by Justin Paolini

Most books, courses and online resources on trading cover the same 50 year old concepts that everyone knows and that obviously will not help readers comprehend the nature of market movement or how to trade consistently. Most resources are full of intricate descriptions of technical indicators, yet very few spend more than a few pages on macroeconomic indicators. So in this article we’ll once more go down the contrarian route and illustrate the direct connection between some leading indicators, Gdp growth and, of course, market movement.

Leading Indicators

You all know by now the fallacies of charts and why I strongly suggest a combined approach of fundamental analysis and technical positioning. Market movement is dictated by a wide variety of agendas and whilst some of them are purely technical and most (nowadays) are algo-driven, I find it essential for us old-fashioned discretionary traders to understand why we should have a bullish or bearish bias on an asset in the first place.

The answer comes from macroeconomic indicators, which give us hints on the health of the economy. Today we’re going to learn about some of the more influential leading indicators. They are called “leading” because they anticipate the turns in the overall business cycle. The leading indicators I prefer to watch are:

  • ISM Manufacturing Index (Manufacturing PMI for the UK & EU)
  • ISM Non-Manufacturing Index (Services PMI for the UK & EU)
  • UoM Consumer Confidence (GFK Consumer Confidence in the UK & German IFO in the EU)
  • Empire State/Philly Fed Indexes (Industial Production for the UK & German ZEW for the EU)

A look at the data:

What makes a Leading Indicator?

Now for the real question: why do these indicators in particular anticipate the turns in the real economy? They are all confidence-based surveys.

Economic decisions are largely based on emotion at the individual and collective level. Individual feelings, impressions and passions are based on:

  • Confidence in future developments: human empathy is one component that aligns our behaviour and positive/negative feelings; then there are feedback cycles: if all your friends are making money just buying any tech stock, it’s going to be very hard to stand aside without feeling “left out” or “dumb”.
  • Expectations: based largely on projections of current conditions/direction into the future and comparing it to the past
  • Aspirations: based largely on desires, not real needs
  • Enforcement of contracts and laws: avoidance of corruption, fairness

Confidence or lack of confidence in the future of the economy is what will guide individual and collective investment/savings decisions. Not interest rates. Not helicopter money. Confidence: without confidence in a better future, people just won’t make investment decisions and will spend less. Businesses will experience rising inventories and falling capacity utilization.

Over to You

Confidence is the key. Keeping an eye on macroeconomic indicators (especially the Leading Indicators) allows us to gauge the underlying confidence in the economy. This is whysentiment (i.e. The theme or narrative in the market) is the key to profitable speculation: it’s not about the data – it’s about people’s interpretation and likely reaction to the data that matters.

Hopefully now it won’t seem too strange that there is a loose correlation between Consumer Confidence and the trend of currencies. After all, the value of a currency is nothing more than the  “degree of confidence” that markets attribute to the nation behind the currency (in this case the UK, as it goes through Brexit).

About the Author

Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.

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