E ach fresh bit of economic news now has the potential to drive stock prices dramatically higher -- or lower. Yet most of us have no idea which economic indicators are the most important... how to track them... or how to incorporate them into our long-term investment strategies.

There are six economic indicators that are especially useful to investors. They are reported in major newspapers and on financial Web sites and television stations.

Here’s what they mean and how to track them...

CONSUMER PRICE INDEX (CPI)

The CPI measures changes in the cost of everything consumers spend money on. Each month, data collectors from the Bureau of Labor Statistics (BLS) record prices on approximately 80,000 different items, from groceries to apartment rents to doctor bills. The BLS issues the CPI report in the middle of each month.

The concern today is that the economy may be overheating, posing the risk of too much demand chasing too little supply -- the driver of inflation.

Prices of consumer goods have been rising by about 2% a year for the past three years. Anything higher is cause for concern. How to react...

If the CPI is flat or lower... stick with your present stock allocation, since strong economic growth -- and a strong stock market -- should continue.

Make big-ticket purchases while inflation is still benign and interest rates are relatively low.

If increases in the CPI accelerate... trim your stock allocation, since inflation is bad for the stock market. Favor cash or a cash equivalent instead.

Timing: Monthly increases in the CPI above four-tenths of 1% would be cause for concern since that would indicate the annual rate of inflation is moving above 4%. But react only when inflation has worsened for 12 months or more. That will tune out short-term events that can cause temporary price spikes.

EMPLOYMENT COST INDEX (ECI)

The ECI measures the cost to business of employing workers. It includes both wages and benefits. The BLS issues it quarterly, about five weeks after the end of the quarter.

If employment costs accelerate, businesses must raise prices -- cutting into consumer purchasing power -- or accept lower profits. Either way, higher employment costs pose a danger to the economy and the stock market.

Federal Reserve Chairman Alan Greenspan follows this report closely, so it generates wide press coverage when it appears.

While higher consumer prices for a month or two may not mean anything, gains in the ECI of more than 4% are cause for concern. How to react...

Strategy: The same as you would use for a high CPI.

Consider reducing your exposure to stocks in favor of cash or cash equivalents. Reason: The higher the ECI goes, the more likely the Federal Reserve is to push interest rates high enough to slow the economy.

If the ECI shows little or no gain, the outlook is for continued solid economic growth with little chance of inflation worsening.

FEDERAL FUNDS RATE

Banks must keep reserves against deposits. This money can’t be lent or invested. If a bank falls short of its required reserves, it borrows for a day or two from a bank with excess reserves. The rate banks pay to borrow is the federal funds rate.

Important: While the Federal Reserve influences all interest rates, the federal funds rate is the one it controls directly. The Fed has raised the federal funds rate six times in the past 12 months. The rate is now 6.5%. Each new increase under Greenspan was aimed at keeping the economy and the market from unreasonable escalations. How to react...

When the federal funds rate holds steady or goes lower... continue to invest aggressively. This means the Fed has no serious fears about inflation -- so neither should you. Take advantage of the benign interest rate environment to invest in real estate, to refinance a mortgage or to make big-ticket purchases.

When the federal funds rate goes up... consider it a direct warning that the Fed is worried about inflation. Take the warning very seriously when the Fed raises the funds rate by more than one-quarter of 1%. Higher rates pose an immediate danger to the stock market, so shift to a defensive stance.

The higher the rate goes, the more sense it makes to shift from stocks to the security of cash or cash equivalents or the potentially higher return available from bonds.

PRODUCTIVITY AND COSTS

The BLS issues this report, which measures the cost efficiency of American workers, about two months after the end of each quarter. There’s talk of a “new economy” because growth in productivity has accelerated -- from 1.5% a year in the 1980s to 2.8% a year now. Even a 1% gain in productivity each year for 10 years would make the economy 10% bigger. How to react...

If the current big gains in productivity continue... the outlook remains positive for strong growth with low inflation. Continue to emphasize technology in your investing.

If growth in productivity slows back to the 1.5% rate of the 1980s... risks of higher inflation increase, and technology stocks become increasingly vulnerable. Then it pays to favor “old economy” stocks.

INTERNATIONAL TRADE BALANCE

This report measures the gap between what we buy from foreigners and what foreigners buy from us. The Bureau of Census and Bureau of Economic Analysis release it jointly in the middle of each month. Our deficit in trade with other countries could hit $300 billion this year, making it the darkest rain cloud over the economy. Foreign investors are huge buyers of US securities. If they stop investing here, it could pull a key prop out from under the stock and bond markets. How to react...

If the trade deficit improves... that should keep the bull market running -- making it smart to keep investing in US stocks.

If the trade deficit keeps getting worse... the bull market will be at greater and greater risk. Consider switching a portion of your investments to cash or cash equivalents and bonds.

THE S&P 500

The S&P 500 itself is a leading economic indicator, but most people don’t realize it.

I focus on the price-to-earnings ratio (P/E) of the S&P 500 stocks. Historically, it has been around 15. Lately it has been 25 -- and higher. That is a huge number. How to react...

If the S&P 500 P/E trends lower... you can feel comfortable being heavily invested in stocks.

If the S&P 500 P/E stays where it is or trends higher... be very wary of increasing your stock exposure. Increase your allocation to cash or a cash equivalent. Technology stocks, in particular, may be at a ceiling at such high valuations.