While leading indicators predict the future and coincident indicators show the present, lagging indicators confirm what has already happened. Though they do not help with prediction, they are essential for confirming that economic trends are genuine and sustainable.
What Are Lagging Economic Indicators?
Lagging indicators are economic metrics that change after the economy has already begun to shift. They follow economic events rather than precede them. While this might seem useless for trading, lagging indicators serve an important purpose: they confirm that changes signaled by leading indicators have actually occurred.
Key insight: Lagging indicators help avoid false signals. If leading indicators suggest a recession but lagging indicators remain strong months later, the recession signal may have been a false alarm.
The Seven Major Lagging Indicators
The Conference Board's Lagging Economic Index combines seven components:
1. Average Duration of Unemployment
This measures how long unemployed workers have been searching for jobs. It rises during recessions as jobs become harder to find and falls during expansions as hiring accelerates.
- Why it lags: Employers cut workers after the economy weakens
- Typical lag: Peaks several months after recession ends
- Trading use: Confirms labor market recovery is genuine
2. Inventory-to-Sales Ratio
This measures the relationship between business inventories and sales. When inventories pile up relative to sales, it signals economic weakness.
- Why it lags: Businesses adjust inventories after demand changes
- Typical lag: Changes months after economic turning points
- Trading use: Confirms demand trends
3. Change in Labor Cost per Unit of Output
Unit labor costs measure how much companies pay workers relative to their productivity. Rising unit labor costs can signal inflationary pressure.
- Why it lags: Wage changes follow employment changes
- Typical lag: Several quarters behind business cycle
- Trading use: Signals inflation pressure and margin compression
4. Average Prime Rate
The prime rate is the interest rate banks charge their best customers. It follows the federal funds rate and reflects overall credit conditions.
- Why it lags: Banks adjust after the Fed moves rates
- Typical lag: Changes shortly after Fed policy changes
- Trading use: Confirms monetary policy impact
5. Commercial and Industrial Loans Outstanding
This measures borrowing by businesses. Loan growth follows economic activity as companies borrow to fund operations and expansion.
- Why it lags: Borrowing responds to economic conditions
- Typical lag: Changes quarters after economic shifts
- Trading use: Confirms business activity trends
6. Consumer Price Index for Services
Service inflation tends to be stickier than goods inflation and typically changes direction after the broader economy.
- Why it lags: Service prices adjust slowly to economic changes
- Typical lag: Continues rising into recessions
- Trading use: Critical for Fed policy expectations
7. Ratio of Consumer Credit to Personal Income
This measures household debt burden relative to income. High ratios can signal consumer stress and potential future weakness.
- Why it lags: Debt accumulates over economic cycles
- Typical lag: Peaks well into expansions
- Trading use: Signals consumer sector health
Unemployment Rate: Classic Lagging Indicator
The unemployment rate during the 2008-2009 recession:
- Recession began: December 2007
- Unemployment rate then: 5.0%
- Recession ended: June 2009
- Unemployment rate then: 9.5%
- Unemployment rate peak: 10.0% (October 2009 - 4 months after recession ended!)
This shows how the unemployment rate continued rising even after the recession officially ended.
How to Use Lagging Indicators in Trading
Strategy 1: Confirmation Trading
Use lagging indicators to confirm signals from leading indicators:
- Leading indicators turn down and lagging indicators follow: Confirms economic weakness
- Leading indicators turn down but lagging indicators stay strong: Possible false signal
- Leading indicators turn up and lagging indicators improve: Recovery confirmed
Strategy 2: Trend Persistence
Lagging indicators help determine if trends have legs:
- When lagging indicators align with leading indicators, trends are more sustainable
- Divergences between leading and lagging indicators suggest caution
- Multiple lagging indicators confirming adds confidence
Strategy 3: Fed Policy Anticipation
Lagging indicators, especially inflation metrics, are crucial for anticipating Fed policy:
- The Fed watches lagging inflation data closely
- High lagging inflation keeps Fed hawkish even if leading indicators weaken
- Falling lagging inflation opens the door to rate cuts
The Fed's dilemma: The Fed often must choose between responding to leading indicators (which suggest future weakness) and lagging indicators (which show current inflation). This tension creates significant market uncertainty.
Corporate Profits as a Lagging Indicator
While not part of the official index, corporate profits are an important lagging indicator:
- Profits respond to economic conditions with a lag
- Companies cut costs and adjust operations over time
- Peak profits often occur after peak economic growth
- Trough profits often occur after the recession has ended
Comparing All Three Types
| Type | Purpose | Trading Use |
|---|---|---|
| **Leading** | Predict future | Position early |
| **Coincident** | Show current state | Verify conditions |
| **Lagging** | Confirm trends | Validate signals |
Common Mistakes with Lagging Indicators
- Using them for timing: By the time they change, the move has happened
- Ignoring them entirely: They provide valuable confirmation
- Waiting for perfection: Do not wait for all lagging indicators to align before acting
- Overweighting recent data: Single data points can be misleading
- Forgetting they lag: Do not panic if lagging indicators worsen during a recovery
The Role of Inflation Data
CPI and PCE inflation metrics are particularly important lagging indicators because they drive Fed policy:
- Core CPI (excluding food and energy) is especially watched
- Year-over-year comparisons smooth out noise
- The Fed's 2% target is measured by PCE inflation
- Service inflation is stickier than goods inflation
Track Economic Indicators and Your Performance
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Summary
Lagging indicators confirm economic trends after they have begun. While they cannot predict the future, they are essential for validating signals from leading indicators and understanding the true state of the economy. The unemployment rate, CPI, and corporate profits are key lagging metrics. Use them alongside leading and coincident indicators for a complete economic picture, and remember that the Fed watches lagging inflation data closely when making policy decisions.
Want to learn more? Read about leading economic indicators or explore coincident indicators.