Investors have been trained to keep one eye on the economy, even as they assess the prospects for their various stock, bond and fund investments. Yet it’s what they track that is crucial.

Some economic measures, such as the Consumer Price Index, the Redbook monthly retail survey or the monthly snapshot of import and export volumes, simply don’t matter much right now.

Instead, it pays to track three other sets of economic data that have a great deal of relevance in today’s economy. You should familiarize yourself with these indicators to get a sense of where the economy and the markets will be six or 12 months from now. Simply put, they could make or break your portfolio. Here they are…

1. NFIB Small Business Optimism Index
Investors have a clear read on what major U.S. companies are doing. We saw these companies lay off many workers a few years ago, which subsequently set the stage for rising profit margins. Now, they are maintaining staff levels, right-sized for the current economic environment. Economists say this dynamic is a lagging indicator, cutting staff after business conditions have soured or adding to staff after demand has moved to a sustainably higher level.

So you will find a leading indicator with the National Federation of Independent Business (NFIB) Small Business Optimism Index. These firms have a direct read on how many customers are walking in the door, and how much they are spending. So when they are pessimistic, these small-business owners curtail their own spending and hiring plans, spreading a negative multiplier effect across the economy.

The good news: these folks are feeling just a little more optimistic these days (though “less pessimistic” is probably a more accurate description). A reading of 100 implies a neutral opinion. The index bottomed out at 81.0 in March 2009, which coincided with a major rally that has since pushed the S&P 500 up more than 100%.

The NFIB index wobbled in the 80s for the next 18 months, only settling back into the low 90s in late 2010. A move back below 90 last summer coincided with a sharp sell-off in the market. Yet since last August, it has risen for five straight months, up to a current 93.9.

But investors shouldn’t get complacent. This index actually spiked to 94 last January and February and then dropped back into the 80s. If you sold stocks in April after seeing the NFIB pullback in March 2011, then you would have avoided the heavy losses the market produced later that summer.

Circle your calendar for March 13, when the NFIB will release a snapshot of February sentiment.

2. Chicago Fed National Activity Index (CFNAI)
Investors are continually trying to gauge how the economy is growing in quarterly increments. But by the time finalized quarterly gross domestic product growth rates are released, the info is stale. For example, we won’t hear about the fourth quarter of 2011 until March 29, when a last and more accurate reading is offered.

The CFNAI, on the other hand, is timelier, yielding a monthly snapshot of the economic growth rate. It gathers 85 inputs, covering virtually every aspect of the U.S. economy and translates it all into one handy number.

It’s a bit tricky to understand metric. The index establishes a baseline of normal activity, known as the trend rate of growth, currently considered to be around 2.5% to 3.0%. It then notes whether the economy is growing above or below this trend rate. Any reading below -0.70 is considered to be a harbinger of a big economic slowdown, and even a drift in that direction can be worrisome.

This index hit +0.54% in December 2011 — a very bullish reading, and was a still-positive +0.22% in January. (The three-month moving average was +0.06% in December and +0.14% in January.) This index spiked in February and March 2011 before trending back down in the spring and summer. And as I noted a few weeks ago, some economists say the economy can’t maintain its recent stronger pace.

I hope they’re wrong, but I’ll be watching the CFNAI like a hawk.

Circle your calendar for March 26, when the Chicago Fed will release a snapshot of February economic activity.

3. M2
Investors used to anticipate the direction of interest rates set by the Federal Reserve, but with rates near zero and staying there, many are now focusing on M2, which measures the amount of money in circulation. It can anticipate the pace of economic activity while telling you how much liquidity is sloshing around the investable markets. A big spike in M2 often portends solid gains for more speculative assets such as commodities, small-cap stocks and gold. A big drop in M2 can signal a real drag on economic activity.

M2 went up sharply in the past few years, from $8.5 trillion at the start of 2010 to a recent $9.79 trillion. That’s a much faster growth rate than the broader economy, which is why some say the Fed is inadvertently creating “bubble-like” conditions, as was the case in the middle of the last decade with housing. There are no signs of a bubble right now, but all of the extra liquidity would need to be sopped up if the economy starts to grow at a 3% or faster annual clip.

The Fed may have gotten the message. M2 grew an average of $80 billion per month in the last eight months of 2011, but grew just $26 billion in January 2012.

[block:block=16]Circle your calendar for March 15, when the Fed’s Board of Governors releases the latest read on M2.

Risks to Consider: Economic readings can be erratic, so it’s unwise to quickly adjust your portfolio on just one reading. It’s very important to track a multi-month trend in these measures.

Action to Take –> Investors want a “Goldilocks economy” — neither too hot nor too cold. An upward move in the NFIB and CFNAI indexes would be quite welcome, though it would raise concerns about M2. In an ideal world, the first two measures would rise even as M2 stays flat or shrinks.

If you want to get a leg up on the crowd and anticipate the direction of the economy and stock market, and adjust your portfolio accordingly, then these are the three best indicators to watch.

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