Jun 29, 2008

Watching the Economy - Federal Reserve Interest rate, Inflation, Unemployment, GDP, Consumer Confidence

Economy is the mother's milk for the stock market. Any of the main economic indicators takes a swing in either direction, Stocks take a swing too. At least the cyclical stocks! Policy makers, like the Federal reserve, use economic indicators to determine the status, direction of the economy and how fast is it going.

Unemployment report is one of the main reports that the feds will keenly watch, and we as investors should too. The government and the feds will lose the credibility if the Unemployment rate keeps rising upwards. Rising unemployment is dangerous and can signal impending recession or worsening situation. Here is the correlation of Unemployment report with S&P 500.

Inflation shows its ugly head when there is lot of money chasing to few goods. The feds are very sensitive to the Inflation levels, OR they should be since the inflation can really impact the low income class level. Fed keeps tab on Inflation by measuring Core Price Index (CPI) which measures consumer prices and goods, and by measuring Producer Price Index (PPI) which gauges the average change in selling prices received by domestic producers for their output. A change in the PPI often anticipates a change in the CPI.

Fed tries to control the Inflation by varying the Fed funds rate, and their by influencing the short term interest rates. Since we hope that Fed knows the economy better than an average person, we might find some insight by comparing fed funds rate with the stock market performance.

What is the perception of the public on the economy? Two little different kind of surveys are done by Conference board and by University of Michigan. Both the surveys measure public confidence in the current state of economy and in its future. Since consumer spending accounts for more than two-third of US Gross Domestic Product (GDP), you should generally see the effect of Consumer confidence readings on the stock market.

-Nidhi