Michael Taylor, whom I have read from time to time at an investor website, posted today to his blog a third party's economic barometer together with a stock market chart from 1998 to present. http://www.alamedalearning.com/reality/
I don't know the inputs into this particular barometer, but the idea is intriguing to me. We all "know" that the economy, however defined or measured, is key to investing. We are fairly deluged by economic news coupled to market action from every source.
Stock market lore has long maintained that the market anticipates the economy by perhaps six months at turns into recessions and turns out of them. So the market is often going down before it becomes evident that a recession will start. The Economic Barometer above also shows that to be the case.
The barometer today reminded me of a simple chart I made nearly three years ago when I was exploring EconoMagic which is a fine and free site. Quite by chance I made a chart of inflation-adjusted US total Gross Domestic Product ("THE" economy) divided by the total US civilian labor force. At that time there was a lot of talk about "productivity", and I wondered if it could be measured in this way: by dividing the total value of the economy by the total number of people producing it, not by those consuming it. Well I nearly fell off my chair when EconoMagic drew this chart! The shape of the curve from 1949 was virtually identical to the Dow 30 or Standard & Poors 500 stock indexes.
The stock market in logarithmic scale looks almost exactly like the real GDP/worker chart. Bear in mind that I am using a quarterly average of monthly closes for the SPX and also that quarterly GNP is not finally settled until nearly three months after the quarter's close. Thus I don't think this chart will always be of help in making investment changes. But when I did the first version of this chart in early 2004 bearish sentiment was still quite profound, both with regard to the economy and the markets. This chart helped psychologically in demonstrating how little the economy had really suffered from 2000-2003 compared to the market. It seemed to me that sentiment was far more bearish than was warranted by the facts.
I noticed that the same had been true in 1974 as the market went below the 1970-71 lows while the economy, though weakened did not, even when measured in inflation-adjusted terms. Thus fear and a war were driving sentiment beyond economically rational levels. Partly this is simply human nature, but partly it is the innately logarithmic multiplier of the market compared to the economy. I am not a mathematician nor an economist nor a professional financial analyst, but I suspected then as now that the multiplier effect of stock equity ownership is the reason why the economy and the markets get a bit out of a simple tracking relationship. This sounds so simple as to be simple-minded, since we all "know" that price to earnings ratio multiples are so very important in bull and bear market stock pricing.
But I think there are several new pieces of information in this relationship. One is that even with the price earnings cycle of "valuation", the tracking relationship of GDP/worker and the stock market does not get off course by very much. Secondly it clearly illuminates the tracking error that does occur as almost purely a sentiment function. But it is longer term sentiment than the usual index and stock options and overbought/oversold hyperbole. It is truly a sentiment of GDP magnitude, the sentiment of the majority of the nation. We know, of course, that the majority are right by definition in a democracy but we also know they aren't right forever in the markets. As far as the S&P500 is concerned we can see that stocks are still undervalued, but we know there are many funds and institutions and companies which have matched or exceeded GDP/worker. Some of those not matching up have gained disproportionately this year.
Lastly the relationship of the economy and the markets strongly reinforces the notion that investments need to be long term since the long term is up for well over 200 years in the US. This doesn't mean that specific investments should never be sold, but that one should always be intelligently exposed to the market. The perma-bears would retort that no civilization lasts forever and ours is about to go down to destruction, so this time it's different. In such a case I think one needs to look at the very long term and at a place like Great Britain even more so than the US. In the 1970's it seemed quite likely the UK was truly going down the tubes economically and culturally and would devolve into a little island soviet. But being a resilient people with a rolling democracy, it reinvented itself in a most remarkable fashion. And the same has happened all around the world as more open government, business law, and open markets dictated. Flexibility is an absolute necessity for continued economic growth as it is for continuity of nations and civilizations. This is what is happening now despite retrograde tribalism in southwest Asia.
In the end the chart suggests strongly that longer term fear is still dominant. This in turn suggests that if the economy slows or turns down modestly we could get the buy of the century. Nor is it a terrible investment even now.
The Dow 30 seasonal since the 1960's, as well as seasonals for SP500 futures since their 1982 inception (not shown), were "upside down" for much of 2006 until October when the powerful year end odds continued the strong uptrend from summer. The Dow shows a double top tendency for January and February, while the shorter historical seasonal for SP500 futures normally has topped higher and then has fallen away in mid February. Seasonals are like sports scoring and only tell you what has happened before, but they are useful for handicapping the market. The coming week is one of the stronger seasonal weeks even though it has low low volume.
Last week's drop of nearly 25 points in the SP500 would fall under the rubric of "year end book squaring" which includes portfolio re-balancing, hedging, and tax selling. We might see some "bonus buying" this week. The very short term sentiment measures got re-balanced. The Dow has stayed in its trading band of the last six months but is nearing the up trendline. Several timing methods point to tomorrow for a short term swing turn.
No changes have been made in the mutual fund portfolio, but over the next few months I'll need to separate higher yield investments from capital gain investments and get the former into tax free retirement accounts and the latter in taxable accounts. As I get closer to mandatory, and fully taxable, withdrawals from retirement accounts, I want to keep the higher yield funds away from the tax man and compounding as long as possible. Everything coming out of tax-deferred accounts is taxed as income, so it's wise to get capitals gains sources and non-taxable sources into the otherwise taxable accounts. So high-yield US municipals bonds and funds which throw off little income but a lot of capital gains need to go there. Both moves minimize taxes and keep one from falling into all the traps of progressive taxation of all sorts.
Those who are still in the accumulation and growth phases of portfolios needn't give this much thought and planning. When you are young you can just decide how much volatility you can live with. Generally with each passing decade your volatility threshhold needs to be reduced. You can recover from a 1987 or 2000-2002 event if you are in your 20's and 30's, but after that you can't risk a 50-90% wipeout and expect to come back by retirement time.
Partly by luck and partly by natural aversion to pain I managed to avoid big drawdowns in 1973-74, 1987, and 2000-2002, but I saw a lot of contemporaries awaiting retirement who were substantially wiped out by 2000-2002.
Most of us don't like to think about these matters as they bring home the fact that we are all and always growing "older". So try to think of it from the mathematical viewpoint: when you are 60 years old you have far fewer years in which to recover from a huge drawdown than you do when you're 25. And this is really linear with a flip of the coin at each successive year. Any year could see a bear market. (This is not a prediction, just the luck of the draw.)
If it's too painful to think about it very much or to do anything about it actively, just use those convenient retirement funds which major fund families offer, labeled "Retirement 2020" and so forth. Or hire an investment advisor, which I am not, to get you properly positioned.
None of this has anything to do with speculation. I am talking about what you do with your winnings from speculation and from working and chance inheritance or the lottery. In any event I try not to speculate after December 15 until January. The odds are we will see come sort of market retracement in January and February, but as we saw this year the market can persist to May, or later.
Silver is an industrial metal like copper and zinc and lead and many others. It is produced today primarily as a secondary recovery from other bulk metals mining operations. In all its oxidative states silver is also beautiful and it has therefore always had a jewelry and coinage function. Oxidation means it's a bear to keep shiny, but old silver table ware, coins, and American Native silver jewelry are lovely and worth the effort if you are a collector.
My view for 18 months or so has been that inflation markets would rest after the first wave of inflation which may run for another two decades. Let me restate that to say that I am a long term (a few decades) inflationist. But after an intial recovery from two decades of disinflationary markets ending in the late 1990's and early 2000's, a rest of a year or two or more would be normal. And that's what I think is going on.
The break in silver this week tells me that phase three of the rest period is under way. New York Comex three month forward silver futures finally filled the gaping gap from May 2006 and completed a credible Elliott wave ABC upward retracement from the June low, and has now broken down. One scenario would be for silver to go under $9 per ounce and take "longer than we would guess".