The post Stocks Follow the Economy……Which Continues to Improve appeared first on ValuePlays.
Did I mention, “The stock market is not a ‘get rich quick’ investment?” Did I also mention that as an investment, “Equities never track a smooth line?”
And…Did I mention that history shows that, “It is the market which tracks the economy over the long term and not the reverse?”
First, the Chemical Activity Barometer(CAB) reported at 99.3 this week, a new high in this business cycle. We can expect a 6mos-18mos warning from this economic indicator vs. a peak in the SP500 as can be seen in the accompanying chart below-Chemical Activity Barometer vs. SP500 ($SPY). Please note that the 9/11 Terror Attack resulted in market weakness which lasted till September 2002, but that the economy as reflected in the CAB had actually turned September 2001. The equity markets eventually followed the economic uptrend over the long term. Fundamentals rule stock prices over the long term, but short term they often do not.
If you listen to the media, many believe that the stock market provides instant riches; you have to just hit it right. The truth of this perception is shown in the chart of the S&P 500 w/earnings & Selected P/E Levels. The S&P 500 tracks the underlying earnings which have a long history of growing at ~6.1%. If you identify where the SP500 intersects at a Selected P/E, the S&P 500 performance is the same growth rate as the underlying earnings. It is the volatility and the one off stories in the media which convince many that 20% or even higher is what they should expect.
Most investors average far less than 6.1%. What in fact occurs most often is that investors are scared out of the market by media reports at major and even intermediate market lows. What most investors do is wait till the media reports turn routinely positive information and enter the markets at high levels. Most investors Buy High/Sell Low. Why do they do this?
They do this because they have become convinced (by the media) that markets control the economy. This is a belief which has permeated market psychology. When the media discusses a drop in market confidence leading to a slower economy, many sell their portfolios. Later, well after the market has recovered, the media chatter is about how good things look economically and investors buy back in at much higher prices. This is why most investors fail to even gain the market average return of ~6.1%. The markets actually follow economic fundamentals not the other way around.
If one uses economic guidelines, as I recommend, one invests at the major equity lows and holds till fundamentals, i.e. economics, indicate a peak is at hand. While, one will not precisely capture market lows and peaks, one can generally capture decent long term gains during the economic up-cycle. Once the signal for an economic peak is provided, one’s best option is to invest in 5yr Treasuries. Past cycles show that this would have worked during economic corrections to improve returns.
At the moment, the economic data is positive for equities. Based on past cycles, it appears there remain several years of up-trending economic activity ahead of us. It is during the up-trend when equities out-perform the long term averages. This is precisely why one wants to own equities during economic up-trends and then switch to 5yr Treasuries once economic indicators are signaling the economy has peaked.
