The Stock Market as an Economic Indicator

By Stock Research Pro • March 3rd, 2009

An economic indicator is a statistic that can provide evidence regarding the performance of the economy. The stock market has traditionally been viewed as an indicator of the future performance, primarily due to the fact that a stock is priced according to the expected future performance of a company. In this way, the stock market is forward-looking, with current prices reflecting expected profits and company stability.

Types of Economic Indicators

There are three categories of economic indicators:

Leading Indicators estimate the future performance of the economy and will typically turn downward before a recession and upward in advance of recovery. Leading economic are seen as the most important type of indicators for investors as they can help predict the coming economic climate. The S&P 500 is seen as a leading economic indicator.

Lagged Indicators, such as the unemployment rate, are those indicators that do not change direction until after the economy does, often several quarters later.

Coincident Indicators tend to move at the same time as the economy. The Gross Domestic Product (GDP) falls into this category.

The Stock market as a Predictor of Future Economic Activity

In most valuation models, the price of the stock is based on expected future earnings, discounted to a present value. Because a firm’s profits are linked to the performance of the economy, stock prices are directly affected by expectations about the future direction of the economy. It follows then that, if investors are anticipating strong economic growth, stocks will be priced higher due to the earnings growth that would accompany this prosperity. For this reason, stock investors have a vested interest in accurately predicting the future performance of the economy.

The view of the stock market as a predictor of the future performance of the economy is not without its critics. Those critics often cite the case of “irrational exuberance”, which causes investors to ignore weak or deteriorating economic fundamentals in their pursuit of high returns.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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