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.
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