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investing Understanding Economic Indicators Nearly every week investors see a flow of data that tracks the economy’s performance and gauges its possible direction. Known as economic indicators, the reports describe conditions that can affect the economy and financial markets. Think of economic indicators as snapshots— each a partial glimpse of the economy at a particular moment. The information they DIGGING DEEPER provide can have either a significant effect on near-term market activity or none at all. Two examples: Since late 2008, whenever the jobless rate has approached 10%, the stock market frequently has stalled or retreated; and in late 2010, signs of an improving U.S. economy—indicated by increased hiring and expanding manufacturing—depressed prices on long-term bonds. indicators fall into three main categories (all indicators listed are released monthly) BROAD ECONOMIC SIGNALS These indicators measure macroeconomic factors such as employment and the production of goods and services. Indicator Employment Situation Summary Another influential group of indicators measures consumer spending, which represents about 70% of the nation’s gross domestic product. The Employment Situation Summary conducted by the Bureau of Labor Statistics compiles employment numbers from a survey of households, businesses, and government agencies. Indicator Personal Income and Spending The Department of Commerce’s Personal Income and Outlays report shows how much money consumers spend and save. Possible stock market effect: Lower unemployment trends frequently support higher stock prices, while rising unemployment may portend a stock market downturn. Possible stock market effect: Stronger-than-expected spending levels tend to increase optimism about corporate profits, pushing stock prices higher. Possible bond market effect: Lower unemployment frequently leads to concern about inflation, depressing bond prices. Bonds often respond favorably to higher unemployment, which often leads the Federal Reserve to lower interest rates. Possible bond market effect: Higher spending can increase inflationary pressures, hurting bond prices, which generally are sensitive to price hikes. Indicator Institute for Supply Management Manufacturing Survey The survey of corporate purchasers gauges how optimistic or pessimistic companies are about demand for their goods and services. Taken together, these perspectives can shed light on corporations’ likely future output. 10 CONSUMPTION TRACKERS Indicator Retail Sales Department of Commerce data indicate the overall mood of shoppers based on the money they spent on both small- and big-ticket items. In particular, economists scrutinize so-called core retail sales, which strip out auto, building materials, and gas station sales, due to their volatility. Possible stock market effect: Equity prices may go up following a report that indicates rising production levels. Possible stock market effect: Robust retail sales translate into corporate revenues and ultimately earnings. A leap in sales may lead to bigger profits and higher stock prices. Possible bond market effect: Signs of growing demand and purchasing may cause concerns about higher inflation and interest rates, pushing down bond prices. Possible bond market effect: Fixed income markets get jittery when spending runs up. Again, larger consumer expenditures can act as a harbinger of inflation. T. R O W E PR IC E IN V E STO R JUNE 2011 investing YOUR INVESTMENT STRATEGY Indicators offer a glimpse of a large, complex U.S. economy. Portfolio managers study the figures, along with other data, to help them make decisions about investments. While economic indicators are important, they are not a substitute for the rigorous fundamental research that managers conduct on the stocks and bonds that they select for their portfolios. It’s important, therefore, not to base an investment strategy on the latest economic data but to focus on the individual goals and time horizons that underlie a successful long-term investment strategy. An Economist’s View: Alan Levenson, T. Rowe Price Chief Economist PRICE MEASURES Changes in the prices of goods and services can have major implications for the economy and the markets. Both indicators described below are released monthly. Indicator Consumer Price Index (CPI) The Bureau of Labor Statistics regularly measures the cost of a basket of consumer goods and services. Investors and policymakers watch for changes that can signal inflation or deflation. Possible stock market effect: Mixed. Inflation helps some companies raise prices and profits but can lead to higher costs that can erode earnings. Signs of sustained deflation tend to hurt the stock market. Possible bond market effect: Rising inflation weighs down bond returns because it reduces the value of future interest payments and may lead to higher interest rates. Deflation, or declining prices, can boost returns of certain bonds. Indicator Producer Price Index (PPI) The PPI examines price fluctuations in raw materials, intermediate goods, and finished products. Sharply higher producer prices often point to inflation in the broader economy. Possible stock market effect: Higher PPI readings may signal that the cost of business is increasing, potentially squeezing profits and depressing stock prices. However, producers of raw materials may benefit from a rising PPI. Possible bond market effect: Higher PPI may lead investors to sell bonds out of concern about rising inflation. 107509 06/2011 As the point person on economic matters, Levenson analyzes and interprets reports and communicates his viewpoint to a global team of fund managers and analysts. Levenson uses the data to piece together a big picture of the U.S. economy, which he shares with T. Rowe Price investment management professionals worldwide. He forecasts economic growth and inflation and provides a general assessment of upside and downside risks. This top-down perspective of the economy helps portfolio managers assess risk and is an important component of their investment strategy. Levenson stresses that it’s important to track a number of indicators for a comprehensive assessment of current trends. “A single economic indicator would rarely result in significant portfolio moves,” he explains. The reason is that T. Rowe Price portfolio managers employ a bottom-up approach to investing, which emphasizes the analysis of individual companies, as opposed to a top-down approach, which places more weight on macroeconomic trends. Hear more from Levenson on the latest economic developments at troweprice.com/insights. JUNE 2011 T. R O W E PR IC E IN V E STOR 11