Many traders and investors carefully watch the release of economic indicators such as PMI data to get a glimpse of how the economy is performing.
A release that is perceived as positive or negative can often move the markets. However, it is not always clear which economic indicators are the most important
In this article I am going to look at the US, Eurozone and UK to see how well a selection of popular economic indicators correlate with official GDP growth.
Why do traders follow forward indicators?
Economic indicators are more popular than ever before, even Central Banks are not immune. The Bank of England regularly refers to PMI data when discussing the strength of the British and world Economy.
Despite the fact that studies have shown that stock markets do not have a simple relationship with GDP, economic growth has a big role to play in the financial markets. Economic growth trends affect employment, interest rates and company profits. In the markets today Central Banks are probably the single biggest factor in the price of assets and reading their statements shows that they play very close attention to economic growth.
Economic indicators try to measure the strength of a part of the economy and are useful guides to how the economy is performing. Crucially, some indicators are available well in advance of the official GDP releases. The US and UK release their first estimate of GDP about four weeks after the end of the quarter. The eurozone release their estimate about six weeks after the end of the quarter. The economic indicators used in this study are available within a week or two of the end of the quarter.
The US and UK analyses have used the period Q1 2007 – Q3 2013 and the eurozone analysis has used the period Q3 2007 – Q3 2013. The correlation has been compared using the correlation (R) and R squared. Correlation measures the relationship between the two data series and R squared measures how well we can expect the relationship to predict future data. The data is aggregated by taking the average values for each quarter.
The US – ISM PMI and ECRI WLI
For the US I used the Institute of Supply Management‘s (ISM) Purchasing Managers’ Index (PMI) and the Economic Cycle Research Institute‘s (ECRI) Weekly Leading Index (WLI). The PMI data for services and manufacturing is combined into one index.[table caption=”GDP Correlation” width=”500″ colwidth=”20|50|50″ colalign=”left|center|center”]
The results above show that the PMI data correlates better with GDP than the ECRI data. However, the WLI is updated every week and so is useful to track economic performance within the month.
Despite the fact that the WLI is designed to lead economic cycle my results showed that it has a better correlation with the same time period of GDP.
Eurozone – Markit Composite PMI and the ZEW Indicator of Economic Sentiment
The PMI data is the Markit PMI for the services and manufacturing sectors. The ZEW Indicator is used for the previous quarter because the indicator appears to predict turning points in the trend approximately three months in advance of the GDP data.[table caption=”GDP Correlation” width=”500″ colwidth=”20|50|50″ colalign=”left|center|center”]
The PMI data for the eurozone showed a very similar level of correlation to the PMI for the US.
The ZEW Indicator does not correlate as well as the PMI but it has the advantage of being available three months ahead of the PMI data. This gives traders and investors greater warning about changes in the economic growth cycle.
UK – Markit PMI and the NIESR GDP Estimate
For the UK I used a combination of the Markit PMI data for services, manufacturing and construction. The data is calculated using the relative share of the economy, see my page on UK Economic Growth for more information about this.
The National Institute of Economic and Social Research (NIESR) data is published monthly, covering the previous three month period.[table caption=”GDP Correlation” width=”500″ colwidth=”20|50|50″ colalign=”left|center|center”]
Both economic surveys showed very good correlation with UK economic growth. The NIESR showed an incredible level of 93% correlation. This is partly to be expected because it is the only indicator that specifically tries to replicate GDP however it is based on a smaller amount of information and available two weeks before the first GDP estimate and two months before the final estimate.
The PMI also shows a good level of correlation and is available two weeks earlier than the NIESR data.
- The data suggests that all of the economic surveys have at least some correlation with economic growth.
- The PMI data is all three economies showed a good correlation and these results confirm that it is a very useful guide to economic growth.
- The NIESR had the best level of correlation to GDP growth.
- The ZEW Indicator gave the earliest information about changes in economic growth.