What it means
Leading indicators are the ones worth most attention because they change direction first. New orders for manufactured goods, building permits, average weekly hours worked and consumer sentiment all tend to soften before output and employment do.
Coincident indicators tell you where the economy is right now. Industrial production, retail sales and total employment move roughly in step with the wider cycle and are used to date expansions and contractions.
Lagging indicators confirm a turn after the fact. Unemployment often keeps rising for months after a recovery has begun, because firms wait until demand looks durable before they hire, so it is a poor early warning device.
No single indicator is reliable on its own, which is why composite measures exist. Combining a basket of leading indicators into one index filters out the noise in any individual series and gives a steadier read on direction.
For a business, the practical skill is choosing the two or three indicators that genuinely drive its own demand. A kitchen fitter should watch housing transactions and mortgage approvals far more closely than headline growth figures, because those are the series that reach its order book.
Indicators also differ in how quickly and how reliably they arrive. Survey-based measures are published within days of the month ending but rest on opinion, while official production and trade data are firmer yet appear weeks later and are often revised.
In practice
Real-world examples
Example 1
A commercial kitchen equipment supplier tracks restaurant openings and consumer confidence together. When both weakened for three consecutive months, it cut planned inventory purchases before its own order intake fell.
Example 2
A construction materials merchant follows building permits, which lead actual site activity by roughly six months. The permit data gives it half a year of warning to adjust staffing at each depot.
Example 3
A consumer lender monitors the unemployment rate as a lagging confirmation of the credit environment. Because it lags, the lender pairs it with jobless claims data, which moves far earlier in the cycle.
Think of it
An economic indicator is like the dashboard on your car. Just as your speedometer, fuel gauge, and engine temperature warnings tell you how your vehicle is running and what conditions lie ahead, economic indicators tell you how healthy the business environment is and when you need to slow down or speed up.
Formula
Calculation
Most indicators are simply published figures, but composite indices are commonly summarised with a diffusion index:
Diffusion Index = ((Number of components rising + 0.5 x Number unchanged) / Total number of components) x 100
Suppose a leading index is built from 10 components. In the latest month, 6 are rising, 2 are unchanged and 2 are falling. The diffusion index is ((6 + (0.5 x 2)) / 10) x 100 = ((6 + 1) / 10) x 100 = 70.
A reading above 50 signals that more of the economy is expanding than contracting, so 70 points to a broad-based expansion. If the following month showed only 3 components rising, 1 unchanged and 6 falling, the index would be ((3 + 0.5) / 10) x 100 = 35, a clear signal that the expansion had reversed.Case study
Seen in the real world
Warrenbeck Fasteners is an illustrative, entirely fictional supplier of industrial fixings to machinery manufacturers. For years it planned production purely from its own order book, which meant it discovered every downturn about a quarter after it began.
The operations director built a simple dashboard of three leading indicators relevant to its customers: manufacturing new orders, average weekly hours in the sector, and a purchasing managers' survey. Each was tracked monthly, and a rule was agreed that two consecutive falls in two of the three would trigger a production review.
The trigger fired the following autumn. Warrenbeck reduced its raw material commitments and shortened shift patterns roughly ten weeks before its own orders declined, and in this fictional case it entered the slowdown with normal inventory rather than a warehouse full of stock it could not sell.
Watch out
Common mistakes
- Reading a lagging indicator as a forecast. Unemployment and corporate profits confirm what has already occurred, so acting on them means acting late.
- Following headline national statistics that have little to do with your business. A specialist exporter is far better served by its customers' sector data than by aggregate growth figures.
- Over-reacting to a single month's data. Most series are volatile and get revised, so the direction across three months matters much more than any one reading.
Questions
People also ask
What is the difference between a leading and a coincident indicator?
A leading indicator changes before the wider economy turns, whereas a coincident indicator changes at roughly the same time and simply describes current conditions.
Are surveys such as consumer confidence really useful?
Yes, because spending decisions are shaped by expectations, so sentiment surveys often shift before hard data on spending does.
How many indicators should a business track?
Two or three closely linked to its own demand, reviewed monthly, will nearly always beat a long list nobody has time to interpret.