Fatal flaws in major market indicators

Economists and other market observers pay attention to major market indicators such as gross domestic product (GDP), gross national product (GNP), consumer price index (CPI) and producer price index (PPI) to guide economic conditions And the future direction of the stock market. However, when experts interpret the data, their market forecasts often ignore the potential flaws in the stories told by the indicators. (Also take a look: Overview of economic indicators.)

Of course, every story can have several aspects. When reviewing market forecasts based on economic indicators, investors need to understand all aspects of the story in order to make a fair assessment of the effectiveness of specific indicators. In some cases, the stories told by major economic indicators may not be the best performance they should actually measure.

GDP

Gross domestic product (GDP) is defined as the monetary value of all manufactured goods and services produced within a country. It is usually used as an indicator of a country’s economic health and a standard for measuring the country’s living standards. Of course, this measure is not without critics. They rightly pointed out that GDP does not take into account the so-called underground economy. For whatever reason, all transactions that are not reported to the government are simply excluded from the GDP calculation. For example, family production (the labor value of a full-time spouse) is meaningless, while the service of a maid increases GDP. Other examples of underground production include the time you spend working in the garden or repairing cars.

It is also important to understand that GDP is calculated as production, not destruction, so rebuilding cities after a hurricane can boost GDP, but ignores the billions of dollars in damage caused by the storm. When comparing countries, GDP also provides an imperfect picture, because currency differences and professional commodity production may be difficult to balance for calculation purposes. Similarly, the GDP comparison between a country that has been rebuilt after destruction and a stable and healthy country may make people feel that the former is healthier than the latter. (Also take a look: What is GDP? Why is it so important?)

Not a measure of prosperity

Some critics even argue that GDP is not designed to measure a country’s health, but only to measure a country’s productivity. From this perspective, GDP has nothing to do with the standard of living of a country. Economic production has no insight into the literacy rate, life expectancy, access to health care, leisure time, or overall happiness of a specific population. Although there are correlations between these factors, correlation does not necessarily imply causality. In fact, the Human Development Index used by the United Nations Development Program and the Gross National Happiness Index used by the small country of Bhutan can better distinguish the oppressed ethnic group of illiterate farmers working in sweatshops from the healthy and happy ethnic group. The country receives wages that are fairer than GDP in a safe working environment.

READ ALSO:   Coupon bond

When the theme of inflation emerges, there will be further confusion. Real GDP affects the impact of inflation, including all price changes that occur in a particular year. On the other hand, nominal GDP uses a specific year as the base year to evaluate the GDP of multiple years without making appropriate adjustments to regular price increases. Therefore, the quantity of goods and services evaluated for each year is multiplied by the price of these goods in the base year to provide an even comparison. For those who are not familiar with the terms and their meanings, the use of nominal GDP and real GDP at the same time may cause confusion. (Also take a look: High GDP means economic prosperity, or does it?)

Gross national product

Gross National Product (GNP) measures the economic performance of a country, or measures the products (ie goods and services) produced by its citizens and whether they produce these products within its borders. It includes gross domestic product, plus any income that residents receive from supervised investment, minus income earned by overseas residents in the domestic economy.

Critics of the GNP criticize this indicator as they criticize GDP because it does not value certain activities and does not consider social welfare (poverty, etc.). Another strong criticism of GNP is that the indicator may be almost irrelevant. First, a person can be a citizen of two different countries. Repeatedly counting her productivity does not accurately measure the total global output. Second, there is little benefit for a citizen of one country to produce goods in another country. Depending on the tax structure of the two countries, he may be taxed by his country of nationality, but lacks overall productivity gains.

READ ALSO:   depositary receipt

Like GDP, GNP is also calculated on a nominal and actual basis. Using the wrong method in the comparison can bias the careless investor. (Also take a look: How to use gross national product as an indicator.)

Consumer price index

The Consumer Price Index (CPI) is a series of indicators that reflect the weighted average price of a basket of consumer goods and services. Commodities are weighted in the index according to their share of total consumption expenditure. Changes in CPI are used to assess inflation. Although tracking inflation is a laudable goal that can help consumers and investors understand changes related to the cost of living, understanding CPI is not a simple matter.

The government distributes several CPI variables every month, including:

  • CPI for urban wage earners and civilian workers (CPI-W): This measure does not include professional, managerial or technical workers, self-employed workers, retirees or unemployed people. This indicator only considers the inflation faced by a certain job sector in the population. Obviously, this is not a particularly broad or inclusive index.
  • CPI (CPI-U) for consumers in all cities: The measure only includes urban family members with at least 2,500 residents in certain tracking areas. Rural and military jobs are excluded. CPI-U is the most extensive CPI measurement that covers most people in the country, but it still does not apply to the rural population.
  • Core consumer price index: Due to the volatility of food and energy, the measure does not include them. Of course, food and energy costs have a significant impact on a person’s expenditure budget, and usually have an inevitable impact on consumers. Any measure that fails to capture them is unlikely to reflect the experience of the majority of the population.

The CPI indicator is full of criticism. On the one hand, a basket of commodities is quite static, rarely changes, and may not always reflect commodities that accurately reflect the consumer experience. On the other hand, some critics believe that the CPI overestimates inflation, while others do the opposite.

The CPI may be better than other economic indicators to highlight the degree of confusion investors have in interpreting economic data. These indicators may be useful to economists, but they are quite confusing to ordinary people. (Also take a look: Consumer Price Index: Investor’s Friend.)

Indicators that keep pace with the times

The Producer Price Index (PPI) measures the average change in the sales prices of domestic producers of goods and services over time. Unlike COI, PPI measures price changes from the perspective of the seller.

Fortunately, modern economists and investors have relatively few criticisms of PPI, although this is not always the case. PPI has two practical uses in the business world. From a consumer’s point of view, it allows economists to gauge the future direction of CPI. When the PPI is high, the cost will eventually be passed on to the buyer, and the buyer will therefore face the inflationary pressure of buying goods. In addition, from a company’s perspective, PPI allows standardization of cost of sales and comparisons at a historical level.

Bottom line

Explaining economic indicators is not always a simple process. Just like stock picking, it requires knowledge, skills, a detailed understanding of the subject, and maybe even a little luck. Economists and investors are always looking for better information, and indicators will not change with the changes of the times, and will continue to evolve to keep up with the world around them and the data investors and experts are seeking. (Also take a look: Use coincident and lagging indicators.)

.

Share your love