When it comes to investing or running a business, the more information you have about what’s happening in the world, the better informed your decisions can be. That’s why, if you watch the business news on a regular basis, you’ll often hear the terms ‘leading indicator’ and ‘lagging indicator’.
Simply put, the difference between them is: a leading indicator can be used to predict future events but a lagging indicator only records what’s already happened.
So, for instance, a leading indicator would be an increase in the number of building permits issued in a given month as that may affect the housing market later in the year by increasing inventory.
Stock market indices are also leading indicators; they tend to move ahead of the economy. The decline of the S&P/TSX Composite Index and other world indices in September 2008 indicated that the economy would weaken; it did just that starting in December 2008. Leading indicators are predictive but also imperfect; choosing the right indicator is both a skill and an art with a dash of luck.
Norm Rothery, a chartered financial analyst and investment columnist, doesn’t put much store by stock market indices as a leading indicator for investors. “It’s imperfect and often gives mixed signals,” says Rothery. “And while some investors do use them—macro investors, for instance, or trend investors—most investors shouldn’t rely on them at all for their investing decisions.”
Reading the tea leaves, things look good right now. “There is strong economic growth in Canada and low inflation,” says Dan Hallett, a certified financial analyst. “But the bond yield curve is flat which generally doesn’t bode well.”However, he says, “leading indicators aren’t that useful for the average investor.” They’re better used to predict the health of a business or a country’s economy.
So, who does benefit from using these indicators? Mainly economists and business owners since the numbers can give them some foresight into running their business—or the country.
Still, Hallett believes it’s good for all investors to be informed and aware of the environment they’re investing in—but not necessarily for stock picking.
The lesson? “Understanding leading and lagging indicators keeps you informed and may influence a decision or two that you make here or there in your personal life,” says Hallett. “Sure, be aware of it, but make sure you understand it’s not a driving source of your stock picking decisions.”
Those are best left to your own research, your financial advisor’s advice and the short- and long-term goals you’ve outlined for your money and your life at various stages. Sticking to your savings and investment plan is what will really pay off in the long-term.