The state of the economy plays an important part in the stock market.  Analysts evaluate the economy is great detail as it affects the decisions they make on what sectors or stock to recommend. A strong economy would instigate a different trading strategy compared to a weak economy. These are the seven signs which show that the economy is recovering and gaining strength.

1.Strong employment numbers

To see economic growth there needs to be an increase in Gross Domestic Product (GDP). This can occur through an increase in consumer spending or an increase in products produced. The level of disposable income can determine the demand of consumers. This means that unemployment figures are a very important indicator when deciding if the economy is strong. When there is high unemployment and redundancies, people may have less money to spend on goods and services. Fewer demand for goods and services means that more companies will struggle, which in turn drags down GDP.  The other effect of high unemployment and redundancies is that people who are already employed may not feel secure with their jobs. This can discourage them from spending money and they will save it in case they lose their jobs. Of course, this will also have a negative impact on GDP.

2.Stable Inflation

When inflation is at the desired level of 2-3 per cent consistently then it can indicate that the economy is on track for good economic growth. If inflation is too high, consumers will have less disposable income to spend on goods as their cost of living is too expensive. If consumers don’t have the ability to spend, then it will hinder GDP growth. Low inflation can signify weakness in the economy. High unemployment or low consumer confidence will keep consumer demand lower which stops prices from rising.

3.Interest rates are rising

When interest rates are raised, it is a sign that the economy is recovering. Interest rates are lowered to stimulate the economy by making consumer borrowing easier so people have more money to spend. Low interest rates also encourage businesses to borrow money and invest in their business. When interest rates are increased instead of lowered, it indicates the economy is heating up, in some instances too quickly as the rising interest rates are intended to slow things back down.

4.Wage Growth

Wage growth is necessary to reach the inflation target in Australia. Economic growth can be attributed to consumer demand. However, this spending power is directly related to consumer income. Demand cannot increase if consumers do not have sufficient deposable income to spend money. If productivity is growing then wage growth can grow as well without increasing the real cost of labour for business. This means wage growth follows after a stronger economy once there is more investment and production. There is currently a lack of demand for goods due to low wage growth. If you see wage growth, it is a good indication that the economy has strengthened.

5.High Retail Sales

Household spending contributes to the largest part of the Australian economy. Increased spending means more production, which strengthens the GDP. The retail sales report can be used to predict GDP before these figures are released. A strong economy is indicated when retail sales grow by more 3 percent or more.

6.Higher New Home Sales

The real estate sector contributes to a significant portion of the economy. House building uses goods and services from sectors such as construction, resources (to obtain materials to build the house) and also consumer discretionary sectors (for new home furnishings, appliances and electronics). There is a lot more spending on goods and services from a new house construction than with selling an existing home. This increased demand for goods and services from new home building can raise the GDP.

7.Higher Industrial Production

Higher industrial production is a good indication of a strong economy as manufacturing production data provides important information about a nation’s economic output. An increase in industrial output can mean a strengthening economy as orders for goods rise. Consumer demand is one of the variables which drives a strong GDP number, and manufacturing growth figures can assist economists in evaluating this. Analyst use the PMI (Purchasing manager index) to determine manufacturing levels. This PMI is a monthly survey completed on a group of companies assessing factors such as output, new orders and stock levels.

Lauren Hua is a private client adviser at Fairmont Equities.

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