While you probably hear regular reports about whether the economy is strong or weak, the metrics used to measure economic health can vary significantly. And which indicators you use when tracking the economy can change quite a bit. For instance, the economy can technically be simplified to gross domestic product (GDP), but other factors, including unemployment and market performance, tend to factor heavily into the conversation as well.
In this article, we’ll look at the different parts that make up the broader economy as we know it, as well as our favorite indicators to watch when evaluating how strong the economy is each month.
The basics
The main measurement for the health of the United States economy is GDP—the total value of goods and services we produce. The Commerce Department tracks this number and releases a quarterly report on whether we’re producing more, or fewer, goods and services than the previous quarter.
The Commerce Department then revises this number a few times as more information becomes available. Those revisions mean you may see several, potentially different, numbers reported.
Throughout history, and particularly since the industrial revolution, the trend in economics has been toward growth. As the human population grows, so too do the goods and services we create. Advancements in trade and technology increase our productivity, and we expand production. In healthy economies, we expect GDP to increase in tandem with these developments.
Recessions occur when GDP shrinks for a significant period. In the United States, the measure for this is usually two quarters of decline; however a recession isn’t official until the National Bureau of Economic Research (NBER) declares it to be so. Currently, they look at more than GDP. In their own words:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
As a result of these varied metrics, NBER may not declare a recession until well after the recession has passed. It also makes it important for investors to monitor economic indicators beyond GDP.
Our six economic indicators
At Quorum, we look at six different economic indicators to determine the health of the economy and the likelihood of growth or recession. We already covered the first indicator we watch: GDP. Let’s dig into the remaining five.
Yield curve
The yield curve indicates the interest rate of bonds across varying maturity dates. A normal yield curve shows short-term U.S. Treasury bonds as having lower yields (or interest rates) than long-term U.S. Treasury bonds.
Sometimes, however, the yield curve inverts. When that happens, the interest rate on short-term loans (like a five-year Treasury bond) will post higher yields than long-term loans (like a 30-year Treasury bond). Inverted yield curves are most often the result of the Federal Reserve hiking interest rates.
More important than the yield curve itself, however, may be what it signifies. An inverted yield curve has historically preceded a recession, though it’s never clear when the recession will actually hit or for how long it’ll stay.
Consumer sentiment
While the yield curve can tell us what’s happening under the economic hood, so to speak, it’s equally important to know how Americans are feeling about their money. The University of Michigan tracks this number via its Consumer Sentiment Index.
Each month, the University surveys how people are feeling about their financial stability. Factors like high inflation or geopolitical conflict can make consumer sentiment trend negative. When consumers are concerned about their financial well-being or the overall health of the economy, they tend to pull back spending and even push major milestones, like retirement.
The Fed model
The New York Fed monitors the probability of a recession by looking at data points that include building permits, productivity, and consumption data. For instance, fewer building permits may mean less construction or investment in growth. Lower worker productivity could indicate the country will produce less goods and services in the coming months. When multiple indicators start to slump, the model may start to indicate a recession is on the horizon.
Leading economic indicators
A significant amount of economic data is what economists call “trailing.” For instance, the Consumer Price Index (CPI), a primary metric for tracking inflation, surveys Americans about what things cost. By the time the data is published, these prices are a reflection of a past moment in time. When making economic predictions, economists try to get a sense of what’s next. On the inflation side, they might look at the Producer Price Index (PPI)—which shows what producers are paying—as those costs may be passed on to consumers in coming months.
Fortunately for us, the Conference Board created a Leading Economic Index (LEI) to track economist sentiment for where things are headed, versus where they’ve been. The LEI offers economists early estimations of when the economy may enter a different phase of the business cycle (such as a recession).
The labor market
Each month, the Labor Department releases two important numbers: How many jobs were gained (or lost) and the percentage of the population that’s unemployed. These are popular indicators—you hear them referred to frequently by newscasters and politicians alike. The Federal Reserve also tracks this data closely when making decisions about raising or cutting rates.
One thing to keep in mind: Multiple factors influence the unemployment rate. For instance, often times during economic uncertainty, people will stop looking for work, or retire early. These folks don’t count as unemployed based on labor department criteria, but they still reflect a certain stagnation in the job market. Often, economists and analysts will comb through labor department data looking for trends beyond the headline numbers to get a better sense of what’s happening in the economy overall.
The practical economy
While data and economic indicators can help us understand what’s happening overall, there’s a more important economy to focus on: yours. The way you experience the job market, inflation, interest rates, and more can vary significantly from the numbers that show up in the news.
Beyond that, the economy is much bigger than what’s happening in the United States these days. As the production of goods and services becomes more global, and as trade becomes more constant, the economies of independent countries become more intertwined. War, natural disasters, political instability, and economic turmoil elsewhere in the world can spill over into the U.S., too.
With all of that in mind, the most helpful thing we can say about the economy may be this: Every recession we’ve experienced has ended. Economics is not an exact science. At the end of the day, meeting your family’s financial goals is more important than all of the data combined.
That’s one reason we believe in a long-term approach to investment and portfolio management. It’s also why we track the indicators recapped here—so you don’t have to. If you’re wondering what our six indicators are telling us right now, contact us to discuss.
Read more Quorum insights:
What is “the market”?
Inflation risk: What it is and why it matters
Checklist: What to do after a layoff
