Lagging Indicator

An analyst tracks a data series that turns down at essentially the same moment output and employment turn down, neither foreshadowing the change nor confirming it afterward. Which classification and example fit?

1. A.A leading indicator, such as the number of building permits issued for new housing.Wrong. Permits are granted before construction begins, placing that series ahead of the cycle rather than alongside it.
2. B.A lagging indicator, such as the average duration of unemployment among job seekers.Wrong. How long people have already been jobless can be known only after the fact, which puts it behind the cycle.
3. C.A leading indicator, such as new orders placed with manufacturers for consumer goods.Wrong. Orders precede production and shipments, making that another forward-looking measure.
4. D.A coincident indicator, such as total industrial production across the economy.Correct. Industrial production moves in step with the economy and describes conditions as they currently stand.

Why: Indicators are grouped by their timing against the cycle. Leading series turn before the economy does and are used to anticipate turning points, with building permits, new orders and stock prices among the usual examples. Coincident series move in step with the economy and describe the present, industrial production and personal income among them. Lagging series confirm a change only after it has occurred, such as the average duration of unemployment. The categories concern timing alone, so one subject such as employment can appear in more than one group depending on how it is measured.

A client's target allocation is 60 percent stocks and 40 percent bonds. After a strong equity year the actual mix stands at 72 and 28. What does rebalancing accomplish?

1. A.It raises expected return by concentrating in whichever asset has performed best.Wrong. Rebalancing does the opposite, trimming the winners rather than concentrating further in them.
2. B.It eliminates the portfolio's exposure to broad market declines going forward.Wrong. Any equity allocation leaves market risk in place, and rebalancing sets its size rather than its existence.
3. C.It sells part of what has risen and restores the intended level of risk.Correct. Drift has lifted equity exposure above target, and selling back to target restores the chosen risk level.
4. D.It converts systematic risk into nonsystematic risk that can then be diversified.Wrong. The two categories are not interchangeable, and no trade converts one of them into the other.

Why: An allocation is a statement about how much risk the investor intends to carry, and market movements steadily push the actual mix away from it. After a strong equity year the portfolio holds more stock than intended, so it carries more systematic risk than the plan called for. Rebalancing sells the appreciated asset and buys the lagging one, returning the mix, and with it the risk, to target. The point is discipline about risk rather than a prediction that the winning asset is about to fall.

Output and employment are still at the highest levels of the expansion, but new orders and building permits have begun to slip. What does this pattern most likely signal?

1. A.The economy is at the trough of the cycle and is about to begin expanding.Wrong. A trough follows a period of declining activity, and output and employment here stand at their highs.
2. B.The slip in orders is a lagging confirmation of growth that was already recorded.Wrong. Orders and permits are forward-looking commitments, so they cannot be confirming anything after the fact.
3. C.The expansion is nearing its peak, since leading series turn down first.Correct. Leading indicators roll over before the coincident measures do, which is what an approaching peak looks like.
4. D.The economy is already in contraction, because output has not yet fallen.Wrong. A contraction requires activity to be falling, and the description has activity at its highest point.

Why: The cycle runs expansion, peak, contraction and trough, and different indicator families turn at different moments. Leading series such as new orders, building permits and stock prices reflect decisions about future activity, so they weaken while current output is still strong. Coincident series such as industrial production and personal income mark the peak itself when they finally roll over. Lagging series confirm the change only afterward, which is why relying on them alone leaves an analyst permanently late.