Economic forecasting is a very important aspect of research in any major bank. As the field evolves, some of the concepts which used to work in the past for predicting the economic future have gradually become less and less useful, and new indexes are being created. In the investing industry, too, analysis is key. The ability to see the same picture in a different way, finding new and unique ways to analyse the health of an economy, and thinking outside the box can potentially result in a very profitable portfolio.
An interesting part of this enormous industry is the rise of alternative indicators: economists increasingly try to find correlations between certain aspects of an economy and ‘exotic’ things, and then try to explain those correlations.
Thinking Outside the Box
The Economist’s Big Mac index, for example, attempts to show how far one’s money can go in different countries through the price of a burger.
The Big Mac index is a relatively well-known one, but not that many know about the Hemline index. The Hemline index was presented by George Taylor, who argued that stock prices and the hemline on the women’s dresses have a positive correlation. He observed that whenever an economy experienced economic growth, there was a rise in popularity of shorter skirts (particularly in the 1920s and 1960s).
There is also a men’s underwear index, which measures economic performance. The idea is that men are likely to spend relatively less money on items like underwear or socks during a recession because they can be used over and over again.
There are also many new technical indicators, such as the ‘VIX’ index measuring volatility. Margin Debt, another example, indicates potential market direction. It measures how much investors borrow from brokers to fund their stock purchases, and high Margin Debt can sometimes mean that investors have become over-confident. When the market plunges, some investors may sell their stocks to repay loans, which can make a bad situation even worse, like it was in the 1920s.
A Niche in the Forecasting Market
It is not quite clear what has led to this trend of alternative indicators. But the most popular theory is that many economists started to lose confidence in GDP as a measure of economic well-being and so started to create their own new methods to replace or complement it. But, as Victor Anderson pointed out in his research, there haven’t so far been any truly viable alternatives.
Behavioural investing expert Greg Davies said of these new fashionable indicators:
“A lot of the reasons people like indicators and why they keep being used is that they simplify something complicated, something not intuitively incomprehensible. We have a complicated world and we turn it into stories, and only those that can grab people’s attention are able to survive and others will die out.”
Alternative Indicators: Useful Measures or Red Herrings?
Alternative economic indicators can arguably be classed into two groups. The first is those used to tackle the drawback of GDP as a measurement of the health of an economy: they often try to add to it by taking into account environmental and social costs, as well as income inequality.
The second group uses subjective methods of measuring well-being. And is the subjective nature of many of these indexes that leads to there being little to no empirical evidence suggesting that any of them actually work to predict the future of an economy. In addition, the data used is often collected through survey results, which is not always a reliable method. Then, when they are analysed interpreted, there is always potential for a lack of standardisation and objectivity.
The Advantages of Breaking the Mould
It has become clear that many of these new indicators have relatively limited use, and investors should avoid making decisions influenced excessively by such indexes. However, they can be an important extension to traders’ strategy or serve as confirmation for a certain trend.
While there is limited use for such indicators in the private sector, they can nonetheless inform public policy, and afford another perspective to public officials helping them to allocate government spending and improve collective well-being. Using new methods and focusing on other sectors, would likely otherwise be problematic if the state only took into account a traditional economic approach.
There is also a lot to be said for these indicators’ ability to grab attention. This can help to popularise the science of economics, especially among those of a younger age – some of which could pursue their interest in economics and end up becoming researchers too.