Friday, February 6, 2009

Lagging vs. Leading Indicators

100,000 more job losses than expected... and what does the market do? It rallies over 200 points. So why did this happen? Let's go back to yesterday about 30 minutes before the markets closed. Senate Majority Leader Harry Reid told media outlets he expects the bill to pass as soon as Thursday night. Obviously the news came minutes before the market was closing so investors did not have time to look into the story. As the story developed more, it became clear that Democrats and Republicans were nearing a compromise on the bill and it could be passed at any day now. This was good news as there had been a lot of talk in the news about how the bill was having trouble in the senate. However, we would have to wait until Friday to see the positive impact it would have on the market.

But what other news was coming out on Friday? Unemployment numbers! And boy oh boy were they bad.  Many economist expected a loss of 500,000 jobs in January and it ended up being way more - 598,000. 

So today we had a showdown in the market. Unemployment vs. Stimulus Bill.  On one side, we had really bad news (unemployment) and on the other side we had good news (stimulus bill). Which one would win? Well as seen with the 200+ point rally in the Dow Jones, obviously the stimulus bill won, but why? This bring us to a fundamental concept of the stock market. The stock market looks to the FUTURE. The stock market doesn't care about the past, it cares about what is going to happen in the future. Investors wants to know how the revenues and performance of a company are going to be in the future. With stocks, you are trying to predict how companies are going to perform in the future.

Unemployment rate is a lagging indicator, meaning it is something that comes out after it already has happened. The unemployment data is giving us data about a time period that has already passed. The stimulus bill is a leading indicator, meaning it is something that is going to impact the future, but has not happened yet. We know billions of dollars in  spending is going to occur, but it will occur in the future, none of that money has been spent yet. Since the market is trying to predict the future, a leading indicator is much more important that a lagging indicator, which is why you saw that news of the stimulus bill caused the market to rally, and the new dismal news of unemployment did nothing. With the stimulus bill, investors can look to the future and see that it will cause the economy and business revenue to rise, which is why we had the rally today.

Remember, don't get caught up in lagging indicators, they can often give you a misperception of what is going on, leading indicators are a much better way to predict what a company is going to do in the future. However, that isn't to say that lagging indicators don't have an impact on the market, obviously unemployment is one of the largest influences on the market, but that usually a leading indicator is more important.

No comments:

Post a Comment