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Leading and lagging indicators

Investing in financial markets requires its fair share of decision making. Assuming individuals are rational in their decisions, market knowledge would want to be known beforehand for a better understanding of the state an economy is in. In assessing an economy, indicators help investors form opinions on the direction of financial markets, and these come in the form of leading and lagging factors.

Leading indicators are usually determined through the markets. Equity prices and bond yields can help determine the direction investor sentiment is taking vis-à-vis specific asset classes. Taking bond yields as an example, falling government bond yields could suggest, amongst other things, pessimism by investors on the economic outlook, as government bonds (Investment grade) are usually the main safe haven assets investors turn to in times of uncertainty and volatility. The opposite occurs when sentiment takes a turn in the opposite direction.

As markets cannot be predicted, investor money flows are monitored closely to generate a broad globalised opinion on the path global investors believe an economy to be taking.

In hand with lagging indicators, efficiently reading and identifying leading indicators is crucial for investors and investment managers alike in order to beat market benchmarks.

Market benchmarks often consist of a pool of securities belonging to a generic or concentrated sector of the economy. Commonly known benchmarks include the S&P 500 and FTSE 100 indices, which are equity indices in the US and UK, respectively.

Although less commonly known, fixed income benchmark indices also exist, whereby bonds with similar credit ratings and maturities are pooled together. The performance of fixed income benchmarks in fact help investment managers identify under or overvalued fixed income securities which usually trade over the counter through multiple pricing sources, unlike equities, which trade over a stock exchange.

Lagging indicators, meanwhile, are available through monthly economic data figures issued throughout respective economies. The main determinants of an economy’s wellbeing fall upon inflation data, the labour market coupled with unemployment rates and industrial production levels. Many more indicators exist but the aforementioned are some of the most crucial.

It is important to note however, that a positive set of data results for a previous month’s data range does not necessarily justify the current economic situation, although there would be a high probability that positive momentum should continue, bar any significant headwinds and volatility.

In fact, the current ongoing global uncertainty has been proved difficult for investors to combine both lagging and leading indicators in generating a profitable long term strategy. Data figures, notably in the US, have alternated between positive and negative over recent months, leaving investors uncertain as to where to park their funds.

With no indications of global uncertainty fading anytime soon, lagging indicators and central bank decisions are unfortunately going to continue making up the biggest part of investment decisions, given the unclarity of the ever changing leading indicators.

 

This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt  The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.  

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