Studies prove that the majority of a company’s performance is the result of external factors. With the global economy changing faster and with more volatility than ever before, paying attention to and leveraging leading indicators will mean the difference in winning or losing for all companies in today’s fast paced economy. Leading economic indicators not only show how things outside of the business are currently affecting company performance, but they also provide a future gauge of momentum going forward.
So what exactly is an Industry Leading Indicator and how can you use them?
Think of the economy as a large machine that has many different pieces and parts that work together in a certain order. Much like a train, there is a locomotive, cars in the middle, and lastly the caboose. The engine heads around a turn first, then the cars follow, and the caboose is the last to change direction. The economy is similar in that there are certain industries/parts of the economy that move in one direction first and others follow. It is important to see how the trends toward the engine will eventually influence your business.
One challenge in identifying these trend shifts in the foremost part of the economy is that when looking at individual components alone, they may not all be heading in the same direction. Two may be rising while three may be falling. Does that mean that momentum in the industry will be waning, or could it pick up during the coming months? Which trend should get more weight? An Industry Leading Indicator is a statistical combination of multiple leading macroeconomic trends, creating a single line representing the future momentum of the industry.
You can use these indicators as a quick snapshot of how the industry is currently performing and how it will likely perform in the future. For example, if the Industry Leading Indicator is portraying a declining trend and it leads the industry by eight months, then we can assume that eight months from now, momentum in the industry will be waning. You can also use them to compare how your business is performing against the industry as a whole.
Industry Leading Indicators can be very beneficial in the forecasting process and provide a solid starting point for statistical modeling. An Industry Leading Indicator can often be used in combination with geographic, demographic and company-specific data inputs to create a highly accurate company sales-channel forecast model.
Let’s take a look at the example below. Here we have Prevedere’s proprietary Nonresidential Construction Leading Indicator (red line) and Total Nonresidential Construction Spending in the United States (green line). We are looking at a year-over-year growth rate where we compare the three- month moving average to the same period of the prior year. When the lines are rising, activity is accelerating, and when the lines are declining, activity is decelerating or contracting. The first chart shows the two datasets charted in real time. We can see that the red line reaches highs and lows, or inflection points, well before the green line. Therefore, it is a leading indicator.
In the next chart, we have shifted the Total Nonresidential Construction Spending line backward 8 months to show the 8-month lead-time that the Industry Leading Indicator has to Total Nonresidential Construction Spending. We can see that the red line extends further than the green line – 8 months to be exact. We can look at this information as a rough gauge of the future momentum in Total Nonresidential Construction Spending. The red line moving lower tells us that while the green line is rising right now, as we head through the next 8 months, the green line will likely begin to decline and momentum in Total Nonresidential Construction Spending will wane. We will want to monitor this indicator each month and look for the red line to turn and start to head higher once more, because this will tell us when activity will start to accelerate again – 8 months in advance.
While Industry Leading Indicators are very useful for examining the future MOMENTUM of an industry, there are a few things to keep in mind when using them. First, an Industry Leading Indicator alone is NOT a forecast. If the Leading Indicator on a three period year-over-year basis is up 5%, that does not mean that in 8 months the specific industry will be growing at a 5% pace. Second, although these Industry Leading Indicators may be highly correlated to a specific company within that industry, they are not a stand-alone forecast for individual companies. Some companies may find that their business falls by a factor more or less than the indicator itself.
We are focusing on Industry Leading Indicators as a gauge of future momentum, not an actual rate of growth. These indicators can be key starting points to creating a forecast model that also includes other non-industry specific inputs, such as weather, geographic factors, demographic factors or internal company metrics.
The difficult problem, however, is sifting through the copious amounts of data available to determine what key indicators are driving your business and your industry. That’s where Prevedere can help. Contact us today to learn how to leverage Industry Leading Indicators in your business.